Blame the endowment effect

Published date: 03/11/2019
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Are you finding yourself emotionally attached to all your trades? Do you usually tend to move stop-losses because you trust too much in your position? Do you tend to be greedy while you are trading your favourite pairs? … Watch out, you may be already under the endowment effect. 

Kahneman, D in his paper titled “The endowment effect, loss aversion, and status quo bias” for the Journal of Economic Perspectives, described the effect in the following manner: 

“The endowment bias occurs when we overvalue something that we own, regardless of its objective market value. It describes a circumstance in which an individual places a higher value on an object that they already own than the value they would place on that same object if they did not own it."

 

Every day, hundreds of traders suffer the effect of the bias while trading forex. They tend to attach themselves to their positions because they are too attached to their money and their “golden pairs”. From moving their SL when they shouldn't, to feel over convinced that a certain trend will continue, those are all psychological tricks or created by the mind. 

For instance, if you trade 24/7 pairs such as GBP/USD and EUR/USD, then you may start to attach your ego to the trades you take on those pairs. With time, you could start giving a symbolic or emotional significance to those forex crosses as your mind convince you of your “level of mastery” on those assets. However, when the trend goes against you, you tell your mind things such as “this is my pair,  I know how it moves, this is just a correction”. This is a clear example of the endowment effect taking place. 

The two main drivers of the endowment effect are loss aversion and ownership. In the first case, traders tend to stick to a losing trade because they are reluctant to lose part of their funds, while in the second case they are against closing a “loser” trade due to the value given to the pair. 

 

Some of the questions that may help you to identify if you are suffering from this effect are the following:

  • Am I assigning greater value to this trade/pair than others?

  • Am I moving the SL because it is necessary due to market structure or because my ego tells me so?

  • Am I treating this trade/pair objectively? 

  • Am I holding this position more than I should? 


 

“Endowment effect” or “emotional attachment”, you can assign the name you want to this psychological trick. The most important thing is to realize that if you cannot control your emotions, you cannot control your money. 

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