Following on from the earlier test here is another example of the biases that can thwart us in our trading ambitions.

Don’t believe you suffer from any behavioral biases  ??? – well try this test then – just two questions with two choices each

Again give your answers before reading past the questions.

What would you  honestly do if confronted with these choices in real life

(1) Would you prefer to take

1.      A sure gain of £24,000 or

2.      A 25% chance of making £100,000 but with a 75% chance of gaining nothing at all.

(2) Would you  be prepared to swallow

1.      C) A sure loss of £75,000 or prefer

2.      D) A 75% chance of losing £100,000 and a 25% chance of losing nothing

SEE ANSWERS BELOW

Most people choose  A and D.

This combination  is actually illogical  and demonstrates our  tendency to succumb to cognitive biases:

Choosing A over B is consistent with  risk aversion

Whilst  choosing D over C is consistent with  risk seeking

Choosing  A over B  highlights the fact that most people are  risk averse with respect to gains – they  prefer to bank a smaller sure gain than take the  better probability bet albeit with the chance of  possibly coming away with nothing at all – ie in trading we have the overwhelming tendency to grab at small profits when the opportunity presents itself  rather than let them run even if that is probabilistically the best option.

However choosing  D over C indicates that people are prepared to take risks and bet against the probabilities  with respect to trying to avoid  losses – we are  prepared to gamble even larger sums  in the hope of eventually reducing an existing  loss  – ie in trading we tend to  hang on to big  losers in the often forlorn hope that they will “come back”  and “save us” from taking that original  loss.

Again these are bad traits for traders to have.

Psychologists  have ascertained that in general people hate losses  around 2.25 times as much as they enjoy an equivalent gain.

This bias is known as “loss aversion” bias and those that got low scores in the CRT test are more susceptible to it, as well as many other behavioural biases, than those that scored high in the CRT test.

The beginners/intermediates course covers psychological biases in more detail – often where traders are going wrong in trading are not just the entries and exits but these related aspects which need to be brought to their attention before they can ultimately succeed.