Myopic loss aversion and market experience█ Myopic loss aversion and market experience
Myopic Loss Aversion (MLA) is a behavioral bias that severely affects trading behavior, particularly the tendency to avoid losses more aggressively than to pursue equivalent gains.
This bias can lead you to make suboptimal decisions, such as selling winning assets too quickly or holding onto losing assets for too long.
Today, we're exploring a study by Mayhewa et al. that explores the interaction between MLA and market experience.
Quick Results: Remarkably, experienced traders showed significantly reduced signs of MLA when operating in familiar market environments or under conditions of low-frequency information updates. This suggests that both familiarity with market dynamics and a strategic reduction in the overload of market information can help temper emotional, short-sighted decision-making.
█ Study Overview
⚪ Methodology and Participant Structure
The research, conducted by leading economists, employed an experimental market setup where participants engaged in trading sessions under controlled conditions.
The study distinguished between inexperienced and experienced traders to gauge how repeated market exposure influences MLA.
Participants were divided into two main groups based on their trading experience, with further subdivisions based on the frequency of financial information they received. One group received continuous updates (high-frequency information), while another received less frequent updates (low-frequency information), allowing the study to isolate the impact of information frequency on trading behavior.
⚪ Experimental Design
The core of the experimental design involved a series of trading tasks where participants were required to make investment decisions across several trading periods. The study introduced a key modification from previous research by incorporating a 'moving average' display—showing the average asset values alongside real-time prices. This addition was intended to reduce cognitive load and help participants make more informed decisions by providing a clearer context for the asset's performance over time.
⚪ Initial Hypotheses
The researchers hypothesized that:
Traders with more market experience would exhibit less myopic loss aversion than their less experienced counterparts.
Providing a moving average of asset values would help mitigate the MLA effect by smoothing out the emotional impact of short-term price fluctuations and emphasizing longer-term trends. Less frequent information updates might reduce MLA by limiting the 'noise' or emotional reaction to price movements, thus encouraging more rational, long-term thinking.
█ Key Findings
⚪ Impact of Information Frequency
The frequency at which traders receive market information plays a crucial role in shaping their trading decisions and susceptibility to Myopic Loss Aversion (MLA).
The study found that high-frequency information updates, which provide continuous price data, tend to exacerbate MLA. This is because constant exposure to market fluctuations heightens emotional responses, leading traders to make more short-term decisions to avoid perceived losses.
Conversely, less frequent information updates can help mitigate MLA. By reducing the noise from constant price movements, traders are encouraged to focus on longer-term trends rather than reacting to short-term volatility.
⚪ Role of Market Experience
The study revealed that experienced traders with substantial exposure to market dynamics show markedly reduced signs of MLA in familiar trading environments. These traders may be better equipped to handle the emotional pressures of trading, well not so much. The research also indicated that experienced traders might revert to MLA behaviors in different trading setups or allocation tasks with which they are less familiar.
⚪ Moving Averages and Cognitive Effects
The findings suggest that displaying moving averages is effective in reducing MLA. Traders with access to moving averages were less likely to make impulsive decisions based on short-term losses.
Instead, they were more inclined to consider the overall trend and value of the asset over time. This cognitive tool helps traders maintain a broader perspective, which is crucial for mitigating emotional biases and making more informed, strategic decisions.
█ Conclusion
Understanding and mitigating Myopic Loss Aversion (MLA) is crucial for improving trading outcomes, particularly in the volatile and fast-paced markets.
Experienced traders tend to exhibit lower levels of MLA in familiar environments, but they are not entirely immune to it.
The context-dependent nature of MLA reduction among experienced traders highlights the importance of continuous adaptation and learning.
Additionally, reducing the frequency of information updates and utilizing moving averages can help traders maintain a broader perspective, further mitigating the impact of MLA.
█ Reference
Mayhew, B. W., & Vitalis, A. (2014). Myopic loss aversion and market experience. Journal of Economic Behavior & Organization, 97, 113-125. doi:10.1016/j.jebo.2013.10.007
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Disclaimer
This is an educational study for entertainment purposes only.
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Marketfluctuations
Reasons for the futility of short-term market fluctuationsAll markets move up and down. Most market fluctuations are not important and trading on them is very dangerous and risky.
Very often, beginners lose money trying to trade intraday on corrections or simply losing sight of the direction of the main trend. Sometimes the market knocks us out on a stop loss, after which it goes in the direction we need. All these errors appear because the trader pays too much attention to the daily price fluctuations in the market.
Today we will look at some facts about price movement and market dynamics that will help you understand why a "smaller" price movement is actually "more" important for trading, as well as some ways to avoid succumbing to the temptation to enter the market on any fluctuations.
Fact 1: Attempts to stop a moving train
If you look at the daily charts of USD/JPY, AUD/USD or EUR/USD pairs, you will notice long multi-month trends. Such trends move with a strong impulse, which is similar to an accelerated train, and they are not able to stop easily and quickly. A strong trend usually continues until something important happens. That is why intraday fluctuations do not matter, they are just noise and it is very difficult to trade on such noise.
Look at the daily currency charts. Daily trends are like moving trains that move in the direction they need almost without stopping, and it takes a lot of force and a lot of time to stop such a movement.
Everyone has heard the old expression: "the trend is your friend." It's true. The trend is your friend as long as you move with it, but as soon as you decide to go against it, it will destroy you, walk over you and not notice. Don't make the typical beginner's mistake, don't try to predict the reversal of a strong trend, don't trade against the trend!
It is trading according to the trend that gives a high probability of earning. Trend trading is the most profitable business, the best time to trade. You have to make sure that you are trading according to the trend if you don't want to get hit by a train.
Fact 2: Losses
No one wants to lose money. This is a fact. Any sane person would agree with that. But as soon as a person is behind the monitor screen, as soon as he starts trading, he immediately forgets about everything and tries to trade on all timeframes, in all known ways, losing all the rules of trading along the way and losing money. Some people trade as if they want to lose their money!
Losing money is a very unpleasant event. We all don't like it. Everyone comes to the market to earn money and this desire sometimes blinds us, and we forget about the most important thing – we don't want to lose money. That is why the most important and first goal of any trader should be to preserve their capital. And the easiest way not to lose money in the market is not to try to trade every price movement. You will not be able to trade these fluctuations, because most of them are just noise that defies logic.
By understanding a few key things, you can really reduce this temptation or get rid of it:
• The best trading setups are obvious. You don't have to be a genius to notice them. If you are sitting in the hope of opening a position, it means that there is not a single worthwhile opportunity on the market for which you could risk! Go away! Save your money! If you value your money, you will not enter the market thoughtlessly. Otherwise, go and gamble, throwing money away and losing it all if you like it.
• By saving your capital (without opening extra positions), when there is no reason to trade, you thereby earn money in the market already by the fact that you will have more money to trade with good trading signals. You should understand that not every price movement in the market makes sense, in fact most of them are meaningless. Learn an effective trading method, like Price Action strategies, master them, and then you will know what to look for in the market. And only after that you should have the discipline and patience to act only when your trading strategy shows you. But if you sit for several hours looking at charts and trying to figure out every tiny price fluctuation, you will surely lose your money, and we all know that losing money sucks.
Fact 3: A long-term trend causes a short-term price movement
If there is a long and strong trend in the market, then most likely the counter-trend short-term fluctuations will not last long. This means that the main trend in the end will still direct short-term fluctuations in the right direction.
This is a very important concept that helps us look for entry points in the direction of the main trend, thereby increasing our chances of winning. Beginners try to take profit from any movement, experienced players act in the direction of the trend and that is why they win at a distance.
Corrections go out faster and they do it unexpectedly, which makes trading on them very dangerous.
Thus, the facts stating that a steady trend behaves like a "freight train", the loss of money sucks in, and a long-term trend causes a short-term price movement are the main reasons why short-term market fluctuations are practically useless.
Traders, if you liked this idea or if you have your own opinion about it, write in the comments. I will be glad 👩💻