This comprehensive field study by Willmana et al., "Traders, Managers, and Loss Aversion in Investment Banking," examines how loss aversion manifests among traders and managers in four major investment banks. The study integrates insights from agency theory and prospect theory to explore the risk management strategies employed by both groups.
"My veto works only one way—to reduce risk." Managers frequently highlighted the importance of controlling downside risk. One manager noted, "My role as a manager is to cover the downside rather than the upside. I try to enforce the discipline of cutting losses rather than pushing them to add to positions."
One trader mentioned, "95% of the time, managers are traders who have been in the business a long time and they have no real management skills." Traders have a strong ethos of autonomy, with managers intervening only when necessary. A manager noted, "I consider I have a veto on any positions my traders take, even when they are within their limits. But, to give you an idea, I think last year I used it once, the year before twice, and this year, not at all."
One trader stated, "Risk tolerance becomes infinite at the end of the year because we don't have any personal exposure to our results in the last couple of months; we can almost become less discriminating in the trades we put on."
By understanding the dynamics of loss aversion and the importance of structured risk management, retail traders can enhance their trading discipline and improve their chances of long-term success.