View previous topic | View next topic

Loss

Page 1 of 3
Goto page 1, 2, 3  Next

ConorOberstIsGo
1058011.  Sat Feb 22, 2014 9:20 am Reply with quote

Loss Aversion is a fascinating part of psychology because it demonstrates us to be - not irrational per se - but our rationality to have major glaring flaws we can compensate for.

More to follow...

 
ConorOberstIsGo
1058030.  Sat Feb 22, 2014 10:46 am Reply with quote

Let me quiz you, please play along :)

Here is decision 1:

Will you choose

a) 80% chance of getting 4000 but a 20% chance of getting 0

or

b) 100% chance of receiving 3000

What's your decision?

Here is decision 2:

Will you choose

a) 80% chance of losing 4000 but a 20% chance of losing 0

or

b) 100% chance of losing 3000

Your decision?



This is from a 1979 study discussing 'Prospect Theory'

Naturally, mathematically most people choose the 'wrong' options : The wise choice would be to gamble to begin with and then accept a 3000 loss in the 2nd instance. But 80% of people choose b) in the 1st decision and 92% choose a) in the 2nd.


An example of loss aversion in the real world might be investors who, when the stock price increases, sell prematurely because they don't want to lose what they've gained.

In the same fashion, the same investors are motivated to hold onto stock which has decreased in value because they are hopeful the stocks may rise above the original value.

So a successful casino would understand that people will often behave more recklessly after they've lost money when gambling than after they've won.



Similar to the first hypothetical questions, psychologists, when posing as utilities company representatives, found that homeowners were almost 3 times as likely to carry out recommended energy efficiency improvements to their home when told they would continue to lose 50 cents a day than those who were told they would save 50 cents if they did carry out the same improvements. These are simply different ways of phrasing the exact same sum but the idea of loss is a great motivator.


Last edited by ConorOberstIsGo on Sun Feb 23, 2014 6:40 am; edited 1 time in total

 
Posital
1058060.  Sat Feb 22, 2014 1:37 pm Reply with quote

The "wrong" option is only wrong if you're able to perform the choice multiple times.

If you have to do something a single time - with clear bandings of outcomes as you describe - then it makes sense to value the reduction in uncertainty.

 
ConorOberstIsGo
1058070.  Sat Feb 22, 2014 2:35 pm Reply with quote

Posital wrote:
The "wrong" option is only wrong if you're able to perform the choice multiple times.

If you have to do something a single time - with clear bandings of outcomes as you describe - then it makes sense to value the reduction in uncertainty.


I see, so you're saying it would be safer to choose b) both times because, while you can afford to win money, you can't afford to lose it?

Your strategy would be different in the long term though, if say, you had ten of each decision to make?

 
knightmare
1058141.  Sun Feb 23, 2014 3:10 am Reply with quote

Quote:
What's your decision?

Your decision?

The wise choice would be to gamble to begin with and then accept a 3000 loss in the 2nd instance.


It's not clear that one has to choose twice, so the first wise choice is to not gamble. One gains 3000, without any known risk.

Next you introduce a mandatory second choice, losing 3200 or the gained 3000, so the second wise choice is to lose the gained 3000.

Of course I'ld accept your first challenge, if I wouldn't have ignored your game show. So I gain 3000, and try to ignore the choice of the second agreement.

Quote:
80% of people choose a) in the 1st decision and 92% choose b) in the 2nd.


Perhaps your example wasn't accurate?

Quote:
An example of loss aversion in the real world might be investors who, when the stock price increases, sell prematurely because they don't want to lose what they've gained.


Certainly not, because the sellers nor shareholders know if it's prematurely. Besides that, you're assuming you know the price the seller paid (is it a gain?), and it would ignore the long-term of typical investing. Perhaps not investing at all, to avoid the stock exchange casino, is a better example of loss aversion.

 
gruff5
1058146.  Sun Feb 23, 2014 4:02 am Reply with quote

ConorOberstIsGo wrote:
But 80% of people choose a) in the 1st decision and 92% choose b) in the 2nd....


Have you got this the right way around? You say "what's your decision" twice, as if the two choices are presented separately & sequentially. I would choose 1)b and 2)a so that I am guaranteed a win in decision 1 (a bummer to lose out on thousands of pounds) and then have a chance of not losing thousands of pounds in decision 2 (which is ... a bummer).

I would have thought my reaction was the norm?

The maths logic only comes in if you have many repetitions of these decisions and you know ahead what both choices are going to be.

 
ConorOberstIsGo
1058174.  Sun Feb 23, 2014 6:27 am Reply with quote

gruff5 wrote:
ConorOberstIsGo wrote:
But 80% of people choose a) in the 1st decision and 92% choose b) in the 2nd....


Have you got this the right way around?



Actually, no I have not.

I have it exactly the wrong way round.

I'm brilliant at this. As you can tell. Have edited to correct.


But all the talk of separately, sequentially etc. doesn't make a difference. If the choices are presented in isolation or together or whatever, people make the same choices. I think you'd have to ask the same question over and over for them to actually figure the right answer out as a strategy.


Last edited by ConorOberstIsGo on Sun Feb 23, 2014 6:40 am; edited 1 time in total

 
ConorOberstIsGo
1058178.  Sun Feb 23, 2014 6:39 am Reply with quote

knightmare wrote:

Of course I'ld accept your first challenge, if I wouldn't have ignored your game show. So I gain 3000, and try to ignore the choice of the second agreement.


Yes yes, the 'wise' choice is to not answer the question in which you lose money obviously but separately or together there is a rational choice and there is an emotional one.

knightmare wrote:

Certainly not, because the sellers nor shareholders know if it's prematurely.


After a legitimate mistake on my part (a)<->b)) I would like to say:

Pretend the data is historical. Now we know that the seller could have made more money if they'd waited. But they quit while they were ahead. Because they didn't want to lose those gains.

Loss aversion crops up in all walks of life esp. shopping. Not investing/Not gambling is not an example of loss aversion.

 
knightmare
1058223.  Sun Feb 23, 2014 9:00 am Reply with quote

Quote:
there is a rational choice and there is an emotional one.


Not ignoring the second challenge, I also will prefer to pay GBP 3000, without risks I wasn't looking for, instead of supporting your GBP 3200 casino scheme. So it's still B&B. Emotionally I really like to think that's a rational decision.

Quote:
Pretend the data is historical.


No, because the seller of the shares doesn't know that. With historical data it's yet another if-then based theory. Besides that, you're still assuming the investor has a (limited) gain. But yes, if you're right, then you're right.

Please note I'm not denying your statement as such, but now the options are GBP 3000 or GBP ?????. By assuming the use of historical data you're assuming that "?????" means "more than 3000". You just don't know that. Nor do I. You have to show that the shares still are too cheap now, instead of smashing a graph in my face after a few months, showing you were right a few months ago. And we shouldn't ignore that not everybody can sell at the highest prices. What about those buyers?

In reality your concept will most likely be related to overvalued shares, so the investor no longer has a good reference and is glad to get rid of the risks. The risks are clear, but the reward isn't.

Again in reality traders not having a clue tend to use a so-called trailing stop loss strategy nowadays.

Quote:
Not investing is not an example of loss aversion.


That wasn't my example. I was talking about not investing in shares, by avoiding the stock exchange casino. It isn't a casino, but people with savings and without knowledge often like to think it's a casino.

 
ConorOberstIsGo
1058234.  Sun Feb 23, 2014 9:33 am Reply with quote

knightmare wrote:
Quote:
there is a rational choice and there is an emotional one.


Emotionally I really like to think that's a rational decision.


Precisely.

Quote:
Pretend the data is historical.


knightmare wrote:

No, because the seller of the shares doesn't know that. With historical data it's yet another if-then based theory. Besides that, you're still assuming the investor has a (limited) gain. But yes, if you're right, then you're right.


Yes, I can't tell the future; guilty. My point is that, with the knowledge one has, people are tempted into cashing when the results are slightly in their favour and staying in the game when the results are massively against them.



knightmare wrote:
Please note I'm not denying your statement as such, but now the options are GBP 3000 or GBP ?????. By assuming the use of historical data you're assuming that "?????" means "more than 3000". You just don't know that. Nor do I. You have to show that the shares still are too cheap now, instead of smashing a graph in my face after a few months, showing you were right a few months ago. And we shouldn't ignore that not everybody can sell at the highest prices. What about those buyers?

In reality your concept will most likely be related to overvalued shares, so the investor no longer has a good reference and is glad to get rid of the risks. The risks are clear, but the reward isn't.

Again in reality traders not having a clue tend to use a so-called trailing stop loss strategy nowadays.


Please explain this trailing stop loss strategy because I am clearly misunderstanding you.

Quote:
Not investing is not an example of loss aversion.


knightmare wrote:
That wasn't my example. I was talking about not investing in shares, by avoiding the stock exchange casino. It isn't a casino, but people with savings and without knowledge often like to think it's a casino.


Okay, I'm sure investment in general takes some wisdom and is not a casino *sigh* but my point still affects even the most savvy of investors. I mean, unless they are aware and compensate and -you don't know the future so how can you know if they compensated too much or too little?-...

 
knightmare
1058272.  Sun Feb 23, 2014 12:59 pm Reply with quote

Quote:
Yes, I can't tell the future; guilty.


Without penalty, I was just trying to point out that using historical data is like knowing now that cup number #5 will hide one of the four GBP 4000 wins. If we pretend to know that, you'ld be an idiot when you accepted GBP 3000 instead of selecting cup #5.

Quote:
people are tempted into cashing when the results are slightly in their favour and staying in the game when the results are massively against them.


Right, that's the part I didn't want to deny. Clueless private investors/gamblers/believers, a small group making a lot of noise, should be familiar with both of your arguments. The mistake of staying in the game is more common.

Perhaps there's an additional problem. A possible solution would be to adopt a MA-based strategy (let your profits run, but sell quite quickly when the price is going down), but the ROI of such a statistically working strategy sucks.

Quote:
Please explain this trailing stop loss strategy


I'm sorry, please try Google or Wikipedia instead of me. I honestly don't like to promote clueless investment strategies. I think I'll agree with any sane explanation of a trailing stop loss sell order.

Quote:
you don't know the future so how can you know if they compensated too much or too little?-...


In general too, the mistakes you described will often occur with predicable listed companies and "cheap" (penny)stocks. Hence me linking it to overvalued stocks. I think it's impossible for you (blame me!) to explain to me, not a believer, why most of those shares would be reasonably cheap, so I would become a shareholder. If I would ever buy such a bubbling share, then I'll be glad to sell it ASAP, accepting any profit. Unless you can explain to me why the share isn't that expensive yet. But that would be like explaining that cup #5 will be a GBP 4000-winner, so I can select it without having to wait for the results.

 
gruff5
1058622.  Mon Feb 24, 2014 9:46 pm Reply with quote

If I was working as a trader (which I am not & never have), I would follow the maths logic of your argument.

But personally, I get much more upset by unexpected/undeserved losses than I get pleasure from unexpected/undeserved gains (almost zero pleasure from those). Given that I don't enjoy being upset and that I have to make the 2 decisions & I know about them both ahead of time, I would choose 1b and 2b so that I don't lose a thing and the bloody "challenge" just goes away!

This seems logical to me.

 
knightmare
1058692.  Tue Feb 25, 2014 6:57 am Reply with quote

Quote:
I would choose 1b and 2b so that I don't lose a thing and the bloody "challenge" just goes away!

This seems logical to me.


I've seen the first "challenge" recently. They pretended to give you GBP 10. When you agreed to receive the money you saw, the next offer was double (GBP 20) or quits (GBP 0). Nobody wanted to play that optional game, so they received GBP 10. In our case it isn't that clear that 1b means you receive GBP 3000 and that 1a is a version of double or quits, but 1a indeed comes down to possibly losing a thing, and you can avoid playing double or quits by choosing 1b.

 
ConorOberstIsGo
1058703.  Tue Feb 25, 2014 7:25 am Reply with quote

I apologise for not communicating very well in this thread but....

gruff5 wrote:
But personally, I get much more upset by unexpected/undeserved losses than I get pleasure from unexpected/undeserved gains....


What you are describing here is exactly loss aversion and while, personally, you might be hyper loss averse, this is an effect which is ingrained human nature.

 
knightmare
1058770.  Tue Feb 25, 2014 10:01 am Reply with quote

Quote:
Quote:
I get much more upset by unexpected/undeserved losses than I get pleasure from unexpected/undeserved gains....


What you are describing here is exactly loss aversion


I'm afraid this isn't a good test, because it requires gruff5's clear description to randomly conclude that it was loss aversion. The best emotional choice, loss aversion, is equal to the best rational choice.

In a way we have to ignore 50% of gruff5's point of view, i.e. his final words, because choosing 1b and 2b "seemed logical to gruff5". I, for one, would say that logic is rational.

 

Page 1 of 3
Goto page 1, 2, 3  Next

All times are GMT - 5 Hours


Display posts from previous:   

Search Search Forums

Powered by phpBB © 2001, 2002 phpBB Group