Today we are going to discuss why people hold losing trades too long.
There are several reasons, and they all come down to human emotions.
In particular, it is due to the ingrained human emotion of hope.
Whenever we are in a bad situation, we hope it will improve.
The investor at a loss might believe that the stock will eventually bounce back and recover its value, so they hold onto it, hoping it will eventually become profitable.
You might have heard someone say, “Oh, that’s just a paper loss.
I won’t sell it, so it’s not a real loss. It will come back eventually.”
While this may be fine for a long-term investor who wants to invest in a company because they believe in its products and services, this can be detrimental to a short-term trader who is interested in capitalizing on price moves.
Holding onto losing positions too long is one of the biggest mistakes that new traders make.
The losses become so big that their winners cannot overcome the loss.
The traders that have learned to overcome this mistake are the ones that eventually become successful.
In order to overcome this mistake, we must know why we are holding onto losing positions. When trading, we have to overcome our natural tendency for hope.
Veteran traders will tell newer traders to “not smoke the hopium pipe.”
To add up to that, additional layers of psychology cause us to hold losing positions too long.
Having an ego in the stock market is not a good thing.
This may be a bigger issue for males than females.
That is why you might find searches that say females make better investors than males.
Have you seen movies where two testosterone males are driving cars heading for each other at high speed?
This guy that swerves away first is known as “chicken” and loses the game.
Don’t play this game — not with cars and not with the stock market.
In the former, you can lose your life. In the latter, you will surely lose your money.
Because the stock market is always right, it will always win.
You, as a trader, will need to swerve out of the way of the oncoming loss.
And the earlier you do this, the less money you will lose.
As traders, we are human and are influenced by our emotions.
We may be afraid of selling the position and recognizing the loss, and it can be emotionally difficult to admit that we are wrong in our initial opinion.
In psychology, this is known as “cognitive dissonance,” where we cannot accept that our investment decision was a mistake, and we hold onto the position to avoid admitting that we were wrong.
As a trader, we have to be humbled. Know that we are not always right.
We cannot be stubborn and maintain our opinion despite facts to the contrary.
Statistically, we are more likely to be wrong.
As soon as we realize we are wrong and react to make corrections, more successful we will become.
Another concept in psychology is the sunk cost fallacy.
This fallacy occurs when someone cannot abandon their opinion or change their course of action because they have already invested so much in the process, even though it is clearly beneficial to do so.
While this fallacy can be seen in all facets of life, it often happens when it relates to finance.
Investors who have already invested so much time and money into the position cannot bear to cut their losses and give up.
Does meditation help with trading?
I have not seen any hard statistics.
However, there are some anecdotal reports that some traders benefit from meditation.
Perhaps, it helps keep their emotions in check and stay calm under crisis.
Or perhaps meditation gives insights into the trader’s own psychology.
Is hope a good thing in trading?
Of course, hope is always a good thing in life.
When you are ill, it is necessary to have hope for getting better.
If you get married, you hope to live happily ever after.
If you start a new job, you hope that it will turn out well.
This is ingrained in our human nature. Hope is a good thing.
However, in trading, it is different.
You cannot hold onto losses too long in hopes of the trade returning to profit.
In trading, we have to switch our mindset.
This is one of the things that makes trading difficult.
Why do most people lose at trading?
Statistics show that the majority of traders lose money in the market.
How can this be?
If markets are random, you would expect 50% to win and 50% to lose.
It is so because we are all human. We essentially behave the same.
The markets have evolved to take advantage of this ingrained human psychology.
Our human psychology is built in such a way that we tend to hang on to losing positions too long, which is the number one way to lose money in the markets.
How can we prevent hope, ego, and sunk cost fallacy from betraying our trading?
Some say that it is necessary to take emotions out of the equation.
To do this, you need to have a clearly documented trading plan with rules.
You simply follow the rules mechanically.
The rules override whatever emotions that may come up.
At the start of each trade, plan what you intend to do if this and that happens.
Follow your plan.
Traders who might not have a clear plan or strategy for managing their positions and who might be uncertain about what to do will surely fall prey to their emotions.
When the trade is in crisis is not the time to figure out what to do next.
Others will say that you have to trade at a size so small that you don’t care.
If you don’t care, your emotions are not going to get in the way as much.
I’m not a psychologist, but I’ve traded for many years and have gone through the many mistakes that all traders go through.
And I’ve worked with many traders.
There does appear to be a common thread that explains why some traders hold onto losing positions too long.
We hope you enjoyed this article on why people hold losing trades too long.
If you have any questions, please send an email or leave a comment below.
Disclaimer: The information above is for educational purposes only and should not be treated as investment advice. The strategy presented would not be suitable for investors who are not familiar with exchange traded options. Any readers interested in this strategy should do their own research and seek advice from a licensed financial adviser.