Holding on to False Hope

Mark Douglas in “The Disciplined Trader” makes the suggestion to “execute your losing trades immediately upon perception that they exist. When losses are predefined and executed without hesitation, there is nothing to consider, weigh, or judge and consequently nothing to tempt yourself with. There will be no threat of allowing yourself the possibility of ultimate disaster.” Douglas’ advice is with merit, however, as pointed out by behavioural economists, following this advice is difficult for traders to follow. Time and time again, even when traders lose a trade, they continue with their trading plan instead of accepting their losses and letting go of them.

So, what is it that makes many of us hold on to the false belief that we can make a losing trade change course? Let’s look at some of the reasons.

According to some research studies, we have a tendency to convince ourselves that if we wait long enough, the trade will turn around. The nature of the market is that it is unpredictable and that can provide us with hope that there is a possibility that the tide will change for the better.

Another reason may be the “sunk cost effect.” A term coined by behavioural economists, this references the original amount of money that is used to purchase a stock. A sunk cost goes up when there is a decrease in value of a stock. Therefore, when a trade is losing, we may tell ourselves that the “true” value is nearer to the original cost instead of the present value and, as a result, we don’t understand why would trade at a loss.

Having unrealistic expectations and denial are possible reasons as well. We naturally gravitate towards avoiding risk. So, when we have wins, we don’t want to risk losing them and therefore hold on to them. However, when there are losses, we start to believe that we have nothing further to lose, so why not take a chance?

Then we have traders who think they have abilities that will somehow  turn a loser into a winner. No matter what, they think they made the best decision and will never concede that they didn’t. These traders will look for anything to prove that their choice was the best one they could make despite the fact that it really wasn’t.

Another take on this situation was a research study where participants were asked if they thought they held on to false hope and losing trades with the belief that they would reverse course. What was found was that approximately half of the respondents said they did. A profile of these traders showed they had less self-control and were less disciplined, both in their trading style and their lives in general. They also tended to rely on gut feelings rather than fact when making decisions and more often experienced negative emotions such as disappointment, fear and anger. While possessing these personality traits may mean that we are more likely to hold on to false hope and losing trades, it doesn’t mean we can’t change if we are willing to put in the extra effort.

We must learn to accept that losses in the market are not unusual. We should anticipate that there will be losses. It isn’t a reflection on who we are and it is important to realise that the nature of the market is simply uncertain. When we learn to put things in perspective and understand this, we will feel less emotional when taking a loss. Finally, begin to let go of losing trades quickly. Holding on to a losing trade and expecting it to turn around will likely end in further disappointment. Instead, we can move on and take advantage of new opportunities.