Trading folklore and managers directly counteract prospect theory’s loss-aversion bias

Evidence

One factor is the lore of traders, in which perhaps the most common maxim “run your profits and cut your losses” (Fenton-O’Creevy Nicholson, Soane, and Willman 2005, p. 192) directly contradicts the predisposition posited by prospect theory. The maxim enjoins traders to continue to hold risky positions when in the domain of gains and to liquidate those in the domain of losses. The need for the maxim suggests that prospect theory’s diagnosis of the typical predisposition is correct, but if the maxim is influential it will counter the predisposition. A second factor again may provide both evidence of the predisposition and a mechanism countering it: the role of traders’ managers, part of whose job is often to discourage undue risk aversion while also detecting and stopping the dangerous “doubling up” of loss-bearing trades (Fenton- O’Creevy, Nicholson, Soane, and Willman 2005). — Donald MacKenzie, An Engine, Not a Camera, 1202

Categorization

• XREF: Links prospect theory in behavioral finance to the performativity thesis — market culture as a corrective mechanism, echoing the wider financialization reading thread. — connects to: Informal managerial risk aversion functions as an unwritten stop-loss in arbitrage — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 1045; Loss aversion predicts status quo preference even without risk — John T. Jost and Jim Sidanius, Political Psychology, 2446; Loss aversion shapes riskless choice, unlike utility theory’s risk dependence (+1 more)

Broader Connections

• People are risk-averse in gains but risk-seeking in losses #expands (0.80) — John T. Jost and Jim Sidanius, Political Psychology, 2406
• Loss aversion predicts status quo preference even without risk #qualifies (0.75) — John T. Jost and Jim Sidanius, Political Psychology, 2446
• Loss aversion shapes riskless choice, unlike utility theory’s risk dependence #qualifies (0.75)