ts loss aversion element
DESCRIPTION
Describes the Loss aversion element at the Tradeslide Challenge.TRANSCRIPT
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Why Loss Aversion (La) matters
• Loss aversion is a cognitive bias from which all humans suffer – and the number 1 reason why inexperienced traders lose
• Loss averse traders “hang on” to losing positions and close winning positions early to “keep” the gains – thus locking in systematic losses
• It is exacerbated by leverage – the more levered, the more loss averse
• For manual traders• If you manage investor money, returns on your own capital are
less relevant as a revenue stream – trading with a higher leverage that you can handle is useless
• If your La is yellow, your strategy is risk averse – possibly as a result of trading with more leverage than your “gut” can handle
• To overcome loss aversion, reduce leverage – and only increase it gradually, as long as La remains magenta
• Algorithmic strategies should not suffer from this bias– algorithmic strategies with non-magenta La may need to re-consider your open/close parameters
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INDEX
1. UNDERSTANDING LA
2. OVERCOMING LA
3. QUESTIONS?
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La – How Loss Aversion is measured
We calculate maximum favourable/adverse excursion for every PositionTo compare the relative size of maximum intra-position wins & losses
Position iTime
Time
Position duration (T)
Min Max CloseOpen
P&L
Intra Position P&L
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Loss aversion is tracked for POSITIONS (NOT TRADES!!!)1 open trade = 1 position, All simultaneously open trades = 1 position! X open positions create 1 new asset
2) USD / CAD
4) EUR / GBP
6) CAD / AUD
Time
1) EUR / JPY
3) USD / JPY
5) EUR / JPY
6 Trades
7 POSITIONS= 7 new assets
1 4 5 6 72 Ex3
La – quick reminder for what a Position is…
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La – a strategy suffering from loss aversion
Maximum favourable excursion wins relatively smaller…
…than maximum adverse excursions!
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La – a strategy without loss aversion
Maximum favourable excursion wins relatively larger…
…outweigh maximum adverse excursions!
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INDEX
1. UNDERSTANDING LA
2. OVERCOMING LA
3. QUESTIONS?
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La is a well researched bias
If you haven’t read this book – don’t resume trading until you doIgnoring your own bias could cost you dearly!
• Loss aversion is a well established phenomenon – around which many business models are based
• Insurance companies• Financial markets trading
• Traders displaying loss aversion will tend to implement systematically losing strategies – a bad recipe for entering the 0 sum game of financial markets
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La is highly non-linear
Loss aversion grows exponentially in high-pressure situationsThe good news is that it’s the trader, not the market, that turns the heat on
• Once aware of loss aversion, most traders grow to control it quickly
• This is the “discipline” to overcome your cognitive bias
• Self-control only works in low pressure environments
• “Pressure” is subjective: different traders have different thresholds from which exponential loss aversion kicks in
• Make sure you set trade leverage to stay well clear of your own threshold – or face BAD consequences
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INDEX
1. UNDERSTANDING LA
2. OVERCOMING LA
3. QUESTIONS?
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Questions?
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