Trading Psychology | Regret Aversion Bias – Would You Rather Be Right, or Avoid Being Wrong?

People exhibiting regret aversion avoid taking decisive actions because they fear that, in hindsight, whatever course they select will prove less than optimal. Basically, this bias seeks to forestall the pain of regret associated with poor decision-making. It is a cognitive phenomenon that often arises in traders, causing them to hold onto losing positions for too long in order to avoid admitting errors and realizing losses.

 

Regret Aversion Bias - Would You Rather Be Right, or Avoid Being Wrong?

Regret Aversion Bias – Would You Rather Be Right, or Avoid Being Wrong?

 

Regret aversion also makes people unduly apprehensive about taking positions after a string of losses, as they feel instinctively driven to conserve, to retreat, and to lick their wounds. This might cause them to hesitate most at moments that actually merit aggressive behaviour.

This can also affect a person’s response to winning positions. For example, traders might be unwillingly to sell an in-the-money position despite negative signals, choosing to cling on to it because they fear that the stock might continue to soar even higher once they sell it.

People who are regret-averse try to avoid distress arising from two types of mistakes, (i) errors of commission and (ii) errors of omission. The former occurs when we take misguided actions, while the latter arises from misguided inaction, that is, opportunities overlooked or foregone.

The other danger comes from “herding behaviour” where traders simply try to follow the crowd, since following the mass consensus diffuses responsibility and hence the potential for future regret.

What is the best solution for this?

“I visualized my grief if the stock market went way up and I wasn’t in it – or if it went way down and I was completely in it. My intention was to minimize my future regret, so I split my retirement plan contributions 50/50 between bonds and equities.” – Harry Markowitz, father of Modern Portfolio Theory

 

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About the author

Spencer Li is a professional trader with over 10 years of market experience, and has been featured in ABC News, NBC, FOX News, CBS News, The Straits Times, The Business Times, My Paper, Lianhe Zaobao, ShareInvestor, Shares Investment, SGX, etc. He has written over 1000 articles on trading, investing & behavioral finance, with over a million readers worldwide, and has personally trained thousands of traders to date. He started off as a self-taught trader by reading over 200 books, and was later hired by professional private equity and proprietary funds to trade for them. After a few years, he was thrust into the media limelight for achieving financial freedom at 27 by trading just 15 minutes a day, while at the same time travelling across 50+ countries. Read his full profile in the "About" section.

 

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  1. […] to Bitcoin to “get it” while others follow the lead of trendsetters or finally succumb to their regret-aversion bias. Either way, these waves of adopters have a destabilizing effect on the exchange rate: speculators […]

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