Trading mistakes: loss aversion
IG senior market analyst Axel Rudolph sits down with IGTV’s Angeline Ong to explain a common trading mistake known as 'loss aversion', how to navigate this trading instinct and how to let your trade run, in a controlled manner.
(Video summary)
The psychology of loss aversion in trading
The video explains the idea of loss aversion and how it affects people's trading behaviors. Loss aversion basically means that people hate losing more than they enjoy gaining. This often leads traders to quickly take their winnings, but hold on to losing positions, hoping they will turn around. Unfortunately, this can backfire and cause even bigger losses.
To avoid falling into this trap, the video suggests a different approach. When traders are making profits and have more money to play with, they should think about increasing their trading size. This means they can take advantage of the good market conditions and potentially make even more money.
On the other hand, when facing losses, it's smart to decrease the trading size. By doing this, traders can limit their losses and avoid digging themselves into a financial hole.
The art of rational trading
In a nutshell, the key is to overcome loss aversion and trade rationally. Adjusting trading size based on market conditions and profits or losses can help manage risks and improve overall trading performance. For example, let's say someone is trading stocks and they're on a winning streak. Instead of cashing out all their winnings, they could use some of the earnings to increase their trading size. This way, they have a chance to make even more money if the market continues to go their way.
On the other hand, if they start losing, it's better to reduce the trading size to protect their capital and limit the damage. By taking this approach, traders can avoid making impulsive decisions driven by fear of losses or greed for quick gains. It's all about finding the right balance and making rational choices based on market conditions and personal circumstances.
This information has been prepared by IG, a trading name of IG Markets Limited. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients. See full non-independent research disclaimer and quarterly summary.
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