market folly

Today's Market Folly quote of the week comes from Jack Schwager, author of many renowned books on financial markets, the aptly named Market Wizards series. Mr. Schwager has had the privilege of interviewing and interacting with many of the top hedge fund managers in the game. As such, he's built up quite a collection of wisdom. Here's our quote of the week focused on human behavior/psychology when it comes to risk & reward:

"In one experiment, subjects were given a hypothetical choice between a sure $3,000 gain versus an 80 percent chance of a $4,000 gain and a 20 percent chance of not getting anything. The vast majority of people preferred the sure $3000 gain, even though the other alternative had a higher expected gain (0.80 X $4,000 = $3,200). Then they flipped the question around and gave people a choice between a certain loss of $3,000 versus an 80 percent chance of losing $4,000 and a 20 percent chance of not losing anything. In this case, the vast majority chose to gamble and take the 80 percent chance of a $4,000 loss, even though the expected loss would be $3,200.

In both cases, people made irrational choices because they selected the alternative with the worse expected gain or greater expected loss. Why? Because the experiment reflects a quirk in human behavior in regards to risk and gain: people are risk averse when it comes to gains, but risk takers when it comes to avoiding a loss. And this relates very much to trading. It is exactly the quirk in human psychology that causes people to let their losses run and cut their profits short. So the old cliché of let your profits run and cut your losses short is actually the exact opposite of what human nature tends to do."

~ Jack Schwager

We highly recommend checking out Jack Schwager's books:

- Market Wizards
- Technical Analysis Study Guide
- Complete Guide to the Futures Markets

They are full of a ton of interviews and insight from top hedge fund managers, traders, and the like.