Why your gut is wrong

Published August 4, 2020           Updated November 1, 2021


Most untrained people lose 67% of the time when they follow their gut.  Why?  All humans hate losing MORE than they love winning. Researchers in behavioral finance have run many experiments to prove this is true, but you can prove it for yourself with this mental exercise.

Consider this scenario: You look down and on the sidewalk see a $20 bill which you grab and put in your pocket happily continuing on your way.  A few blocks later you decide to put that $20 bill in your wallet, but when you open it up, you find it’s missing $50.  Are you still happy about the $20 you found or disappointed about the missing $50?

Now think about how much more money (over the $20 you found) it would take to feel good about your find instead of feeling downcast about the missing $50. Research has been done to show that it usually takes about twice what was lost (in this case $100) to get back to feeling good again.

Now anyone could look at the situation and say something like, “Wow, I found some money! That’s all the matters, I’m happy about THAT!” but the reality is that almost all people do not. They are FAR more likely to join these two experiences in their mind and remain disappointed by the missing money than happy about the unexpected find.

This translates into the markets very well. Your own psychology will attempt to get twice as much gain for whatever loss you suffer. So when you don’t plan a trade, you naturally go into a mode where you risk 1 to make 2 (or more). This strategy is mathematically calculable such that you will only win 33% of the time if you allow your gut to make market decisions.

Some investors make a lot of money risking 1 to make 2.  The value of knowing your natural trading style and corresponding probability profile is having clear expectations about base winning percentages, likely streaks (winning and losing), where to place stop loss and profit target orders, and what strategies and tactics you can focus on to improve your trading edge.  This information gives you everything you need to both improve your results and remain consistently confident in your ability to be successful putting your money to work.

If you want to know what your natural trading style is, click HERE.

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