Behavioural Finance & Day Trading : Taking Profits Too Quickly?

Do you have a major issue with holding on to your winners? Have you found yourself closing out a trade on an emotional decision only to watch the stock skyrocket to all-time highs? Worry not, it's a common problem faced by a lot of new and developing traders. What you might be surprised to hear is that you’re actually hardwired to do this.

There is a branch of Economics called Behavioural Economics which studies psychology as it relates to economic decision-making processes. There was an academic article published in 1999 by O’Donoghue & Rabin titled “Doing it now or later”. What this article found was that given the chose the major of people would choose a reward straight away rather than waiting for an even larger reward at a later date. This is something referred to as the Present Bias.

Although the subject on Present Bias can be multi-factorial and complex, for this blog we’re just going to keep it basic and draw a simple conclusion. What its thought is that Present Bias was probably an inbuilt behaviour that was left over from our caveman days and related to the food supply. We used to be in an environment where food was hard to come by and cost a lot in energy we had to expend to get it. To survive we would always take all of the food in front of us straight.

The way to deal with present bias is to remove discretion from the equation and have a set structured exit that is pre-defined before the trade is entered. This will then ensure that you are not left making emotional decisions in a time poor environment. 

Happy Trading!


Published 05/06/2019

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