How much does a loss really hurt?
Six coin flips show how much bigger a loss feels to you than a win, and what that does to a plan that works on paper.
Free, takes about two minutes, and nothing you answer leaves your device. Imagine the money is real. There are no right answers.
Where do you stop taking the flip?
You will be offered six flips of a fair coin. Each one pays a win if it lands heads and costs a loss of 100 if it lands tails. Take the flip or pass, and go with your gut.
The arithmetic says take every one of them, because each wins more than it can lose. The point is to find where you stop. Treat each flip as the only one you will ever be offered.
A fair coin, played once, with money you would feel. Take the flip or pass.
Your result
How a gain and a loss feel to you
Try a plan against your gut
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A rule for it
One line you can keep where you trade. Save it and it appears on the free tools page.
Saved rules stay on this device. You can see them all on the free tools page.
How it shows up in trading
Loss aversion is not a flaw to remove. It is a weight on one side of the scale that you can account for.
A gain feels fragile
A profit you are holding can disappear, and that loss would feel bigger than the gain did, so you take it early. Studies of brokerage accounts find that investors sell winning positions more readily than losing ones (Odean, 1998).
A loss feels unreal until you take it
Closing a loser makes it final, so the stop moves a little further away. The same pull is behind the habit of holding a position until it gets back to even.
The next trade feels like another loss
Judging each trade on its own makes every one look like a chance to lose. Judged as one of the next twenty, the same trade is just part of the average (Kahneman and Lovallo, 1993).
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The research behind it
- Kahneman, D., and Tversky, A. (1979). Prospect theory: an analysis of decision under risk. Econometrica, 47(2), 263-291.
- Tversky, A., and Kahneman, D. (1992). Advances in prospect theory: cumulative representation of uncertainty. Journal of Risk and Uncertainty, 5(4), 297-323.
- Benartzi, S., and Thaler, R. H. (1995). Myopic loss aversion and the equity premium puzzle. Quarterly Journal of Economics, 110(1), 73-92.
- Kahneman, D., and Lovallo, D. (1993). Timid choices and bold forecasts: a cognitive perspective on risk taking. Management Science, 39(1), 17-31.
- Odean, T. (1998). Are investors reluctant to realize their losses? Journal of Finance, 53(5), 1775-1798.
The Loss Aversion Meter is an educational tool and not a psychological or clinical test. Six flips find your price to within a few units, but answers to imagined bets are noisy, and your mood, the stakes and what happened recently will move the result. Treat it as a rough indication. The typical figure of about two comes from published laboratory studies, and individual results vary widely. The line labelled as how a trade feels uses a simple model in which a win counts once and a loss counts as many times as your ratio. Real feelings also depend on the size of the stakes. The rule suggested is my own practical suggestion, not a research finding. Trading involves risk, and you should only trade with money you can afford to lose.
