‘Trader mindset’ dampens emotional reaction to loss

NYU/CALTECH (US)—For most stock traders, loss is just part of the job—especially in today’s bear market. However, results of a new study suggest that, unlike amateur traders, professionals seem to develop an emotional numbness to losing money.

Researchers at the California Institute of Technology (Caltech) and New York University have found that when people ‘think like a trader,’ they display behaviors that are less averse to loss.

The findings could be relevant to drawing distinctions between amateur and professional traders. Professionals have learned not just facts about investments, but also strategies for limiting the normal emotional response that might prevent amateurs from making the same decisions given the same information.

“These results highlight how a simple shift in perspective can influence both the emotional reaction to a financial decision, and the decision itself,” explains study coauthor Elizabeth Phelps, who is professor of psychology and neural science at NYU.
For the study, the researchers asked subjects to complete a series of 140 choices between a risky gamble and a guaranteed amount of return using two strategies—one emphasizing each choice in isolation and another emphasizing each choice as one of many.

Choices in isolation are analogous to those an amateur trader might make; choices made as one of many are akin to decisions a professional trader would implement because they simulate management of a diversified portfolio. When making choices in isolation many of the subjects were loss averse. That is, they were more concerned about avoiding financial losses than in making financial gains. However, when subjects were asked to make choices using a strategy that emphasized these choices’ larger context as one of many decisions-such as the decisions one would make in managing a portfolio of investments-the vast majority of participants were less loss averse.

“Though on average we may dislike losses more than we like gains, both in our behavior and in our physiological responses to them, it seems we have the power to change that,” says Peter Sokol-Hessner, the study’s lead author and a doctoral student at NYU.

To examine emotional factors that may coincide with the behavioral expression of loss aversion, the researchers measured changes in subjects’ skin conductance due to increased sweating in response to learning the outcomes of their decisions. The results for choices made in isolation showed that subjects sweat significantly more, per dollar, to losses than gains. This “over-arousal” to losses was correlated with behavioral loss aversion, which suggests a specific role for emotions in choice. However, when subjects made decisions using the “portfolio” strategy mentioned above, the over-arousal effect disappeared—average levels of sweating per dollar were about the same for gains and losses.

Coauthor Colin Camerer, a Cal Tech professor of economics, says the role emotions play in economic choices is not well understood. “Showing that emotional reactions can be turned on ‘mute’ shows both that those emotions are genuine and that they can be controlled, which gives a fresh perspective on the role emotional control may play in the economy.”

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