Prospect Theory - Are you ready for FOMC decision?

I cannot wait to win a bronze medal, said no one, ever.  However, research shows that Bronze medalists are usually much happier than those winning Silver.  Just think back to Tanya Harding or Michelle Kwan in the 1998 Olympics.  It seems that being so close to the gold, but ending up with the silver, creates a disappointment in our brain.  However, being close to fourth place and not winning at all, only to make it to the podium and earn a bronze medal, makes for one happy athlete. 

 

Prospect Theory can be applied to many things and explain why  we can feel differently about the same scenario.  In a trading world, the same theory makes us do completely irrational things.  Why do we hold on to a losing trade forever, hoping that it will turn around, but close a successful trade as fast as possible, only to realize that the stock kept gaining momentum long after we closed our position?  Because the feeling of sadness due to a loss is much greater than the joy we feel from an identical gain. 

 

As the prospect theory points out, if we are given $50.00, that makes us happy, but if we are given $100.00 and then have $50.00 taken away, that makes us sad.  How do we avoid becoming victims of the prospect theory?  In Tradespoon, three out of four trades are successful.  Remember, you cannot control the market, but you can control your response to it.  Stick to your trading plan.  Journal your target gains and your target losses.  Recognize your thoughts and, even though losing hurts, enjoy your wins too!