April 1, 2018

Loss aversion

Loss aversion is one reason why people lose a lot of money in the stock markets.

It refers to people's tendency to prefer avoiding losses to acquiring equivalent gains: it is better to not lose Rs.500 than to find Rs.500.

This is the reason why people hate booking losses in stock markets... the pain is too much. You will rather wait, hope, see other alternatives/ possibilities before writing off your loss (which has now grown bigger)

What distinguishes loss aversion from risk aversion is that the utility of a monetary payoff depends on what was previously experienced or was expected to happen.

It is very difficult to overcome this because humans are hardwired to be loss averse due to asymmetric evolutionary pressure on losses and gains: for an organism operating close to the edge of survival, the loss of a day's food could cause death, whereas the gain of an extra day's food would not cause an extra day of life (unless the food could be easily and effectively stored).


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