Loss of Control or Control of Losses?

I've been thinking more about losses and how we deal with them. It seems to me that an experienced trader asks himself, "How much could I lose today?", whereas a beginner wouldn't even contemplate the possibility. Unless the idea of taking a loss is already in your mind then if it comes to the point when you have to, to avoid the possibility of taking an even bigger loss, you won't be able to. If you have read my report (see sidebar for a copy), then you will remember about the work done by Kahneman and Tversky on loss aversion. Having already prepared for the possibility of getting out of a trade early with a small loss, if the market turns against you, then you are partial innoculated against loss aversion.

Deflated bank

Bank: £62

I'm not a happy bunny. My bank is down to nearly half. What happened?

I took two £19 losses and made some little gains and a little loss (which could have been nasty, but I turned it around, just).

My first trade looked very promising. I got in early on an obvious trend. I was quite pleased with myself and was letting it run, when the moment of horror struck. I hadn't checked the software I was using properly before starting and had left on some automatic settings. Each of the backs I had put on had been getting automatically generated lays put on. I checked the matched/unmatched queues and saw several unmatched entries. I was rather exposed and after kicking myself for not paying enough attention I had to go full out to avoid a bad loss. I pulled it back but still made a small loss.

Next up, I did a couple of trades and made some small gains, then I had another bad one. I had put on a lay and was watching the price slowly rising, ready to get out if it turned against me when suddenly, in the blink of an eye, the price dropped a huge amount, at least ten ticks and I was suddenly losing. I sat in shock a couple of seconds, double taking the numbers I was seeing. Time was running out and I needed to take a fair loss and get on, but I didn't. I fell into the trap again. I sat there thinking it'll turn back. It didn't. I ended up letting the bet run and I lost. Stupid. £19 down on that. Okay, not a huge sum, but in proportion to the bank, it is almost 20%.

The final loss was again me getting myself in trouble by not understanding the software. I was making multiple trades on a race and had a few quid in the green. I allowed myself 3 ticks stop loss, which I was handling manually (mistake, I will do this automatically in future). The price moved against me and I hesitated, letting it roll passed my self imposed stop loss trigger (always stick to your rules. Lesson hopefully learnt (again)). After the price moved around, going up and down, with my heart rate matching it, it finally returned to my stop loss value and I tried to get out. I thought I had done it but when I looked at the stake, it was only half what it should have been. I had left the auto hedge fature on (changes the stakes so that you automatically get green ups) whilst having an unmatched back in the queue from earlier. It used the unmatched amount as part of its stake calculation. The price had then moved on again and I was still exposed. For some reason, when I make a silly mistake like this I act like the system no longer applies and once again I let the bet run and I lost.

Lots of lessons to take on board. One big one is that I can't always be trusted to stick to the rules I have set myself. How weird is that. When it comes down to it, in certain circumstances, I feel "above the law"! I hope now that I have noticed this, I can fix it. It's funny but all these reactions are covered in some of the books I have recently read, so it's not like it is new stuff (behavioural finance, kahneman/tversky, etc). It's just different reading and understanding it and then doing it. I hope this lesson is finally learnt. I think I will try and mechanise the process more, using software driven stop losses etc.

Why do we act like idiots?

After my idiot moment last night, where I lost half my bank, I started wondering what is it that makes these things happen. Why did I let my loss run, whereas when I was making a profit, I would be inclined to take it there and then.
I remembered something I had read in a pretty cool book about persuasion and influence (something I have a fascination about), called "The Science of Influence" by Kevin Hogan (pictured below). The book asked a couple of questions that researchers Kahneman, Slovic and Tversky had posed in 1982. Have a go at them:



Situation A:
In a game you receive $1,000 (cool game!). In addition, you have a choice between a certain gain of $500 or a 50 percent chance of winning an additional £1,000 and a 50 percent chance of winning nothing.
Which do you choose?

Situation B:
In a game you receive $2,000. In addition, you have a choice between a certain loss of $500 or a 50 percent risk of losing $1,000 and a 50 percent chance of losing nothing.
Which do you choose?

Hopefully you have made your choices. If not, then re-read the above questions and note down your answers.

-- Don't read on until you have your answers --

Okay, well, basically, both situations are the same but are framed differently (i.e. same meaning but differently directed wording).
In both situations you are deciding whether you want £1,500 guaranteed or a 50 percent chance to end up with either £1,000 or £2,000.

How do most people respond?
In situation A, they found that 84 percent of people chose the certain $1,500 (first option). Only 16 percent of people were willing to gamble on the 50-50 chance of either ending on $1,000 or $2,000.

In situation B, they found that 31 percent chose the certain $1,500 (first option). A huge 69 percent were now willing to gamble of the 50-50 chance of ending up with either $1,000 or $2,000.

The situations are 100% identical yet how they are presented makes all the difference and gives us an indication on how people make decisions.

The lesson: People will lock in a sure gain in favour of any risk in the future, but they will let their losses run.

It is a lesson I hope I have learnt now and in the future can use discipline and make sure I cut my losses and live to fight another day.