Behavioral Economics

 Stock Market Psychology

The name most associated with behavioral economics is Daniel Kahneman--the Nobel Prize-winning psychologist and (nearly) public intellectual because his work is so familiar and he has published well-received books. Adam Tversky was his collaborator--a movie was made about the two. Unfortunately, Tversky died before the aware of the prize

So, in trading stocks, we tend to have a fear of losing money. Loss aversion theory, the centerpiece of the theory, is that losses hurt more than gains feel good. So we sell our winners and hold onto our losers. We don't want to concretize a loss. If. a stock goes down, a trader is more likely to hold on hoping it regresses to the mean Worse, there is a tendency to buy more, or double down, once the stock has fallen. In effect, when we lost, we tend to become even more risky. Meanwhile, we grab that little win--feeling great about the appreciated stock. But those little wins are not sufficient to counter the ocassionally big losses holding onto losing positions. A variant of this is grabbing onto a "falling knife", a stock that has gone down, in hopes that it will go up. Stocks going down unfortunately tend to continue going down. As they say, "the trend is your friend."

This psychological phenomenon works even when the person knows the theory. As the stock fall they may think, we'll I'll hold on, and tomorrow I will start paying attention to Kahneman's Loss Aversion theory. 

I think compulsives have the problem worse than others. Part of that psychodynamic is a tendency to want to correct past errors,, using the Freudian term "undo". And compuslives (more accurately those with features of Obserssive Compulsive Personality) tend to be risk-averse, which I believe probably aggravates the tendency to solidfy losses, to avoid further losses. Anyway, the market algorithms regularly gut those traders, is my guess, identifying just those psychological principles that make people sell en-masse.

Do the principles of loss aversion occur in other aspects of life. Probably, particularly when money is concerned since money is quantifiable, with numbers and exact account. It's easy to spot small losses. Maybe the idea in the economics of "sunken cost" is related. If you buy a ticket to a movie, that is a sunken cost You should not go to that movie if you don't want to, or have changed plans just because you have bought a ticket. The pain of paying for an unused ticket creates a desire to right things by attending, but that creates a loss if the sum "utility" from attending the show is less than the ticket price.