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The “Endowment Effect” just may be the reason you'll fail as a trader

by , 12 March 2018
The “Endowment Effect” just may be the reason you'll fail as a trader
Did you know that you place higher value to things that you own?

To explain this, Pros. Kahneman, Knetsch & Thaler conducted a popular study with 77 participants at Simon Fraser University.

These participants were placed into two groups.

Group #1: Were given mugs (in a way they owned them).

Group #2: Were not given mugs but were asked to price the mugs.

Can you guess who priced the mugs higher?

Yes, Group One had the tendency to price the mugs at a higher value around $7.12 (R84.15).

While Group Two priced the mugs at a lower price around $2.87 (R33.92).

The group of students who owned the mugs felt that they didn't want to give the mug up easily. This is because once gone, part of the students would feel a loss.

So why wouldn't the same be for when you buy a stock, CFD or market?

It is the same… And this bias tendency called “Endowment Theory” just might be the reason you fail as a trader.

Let me explain…

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Why you place higher value on things you own
Before we get into the trading side of things, allow me to elaborate on why the students raised their value of their mugs.
You see, the students who owned the mugs developed a form of appreciation for them. The fact that they now had the chance of losing the mugs, created an unsettling feeling.
This is because human nature is loss-averse. And so they raised the value of the mugs more than the general market perceived.
So what happens when you buy a stock, CFD or even a crypto currency?
Because you own something by value, newbie traders tend to hold onto their positions longer. These are the traders who do not implement any risk or reward levels i.e. stop loss and take profits.
When the market crashes, traders tend to develop a tendency to hold onto their positions because they believe they’re worth more than what the markets are trading at.
I am no exception…

How I blew 30% of my portfolio holding Penny Stocks
When I was around 19 years of age, I needed to find a way to make quick money. Large cap stocks just weren’t making the cut and derivatives were not really available in SA markets.

And so what else could I turn to?

Penny Stocks.

One day I looked at the charts of the Penny Shares and looked for cheap but volatile stocks.

I bought about R70,000 worth of Penny Stocks in one day.

The day I bought them, was the day something inside changed.

I felt that these Penny Stocks should be worth a lot more.

Not because of the fundamentals, not because of the enormity of the companies but because I OWNED A WHOLE LOT OF SHARES.

Two months later, my portfolio was down 10%. Three months later my portfolio was down 20%. Six months later the penny stocks had dropped a whopping 30-40% on average.

And my perception of the stocks were at the point where my ego, pride and optimism for the stocks were ready to shoot through the roof.

One year later, I sold every Penny Share and lost 30% of my portfolio.

I blew a huge chunk of my portfolio, because I didn’t implement a strategy and failed to used logic.

By not implementing a strategy, technical and logic was the reason I blew a huge chunk of my portfolio.

I got suckered in and so I can very much relate to the “Endowment Theory”… I most definitely did not feel very endowed after that ordeal.

And not only me, but 15 of my close trading buddies.

They all fell for this and the stock markets definitely whipped us back into gear.

So what can you do to avoid failing as a trader?

First of all, do yourself a favour.

Take my story into account. Learn from the mistakes I made so you don’t fall for it.

Second… Make sure you have six of these in check before you even place your next trade.
#2: Back tested results on the strategy using a trading journal
#3: Strict stop loss and take profit rules in place
#5: Money you can most definitely afford to trade
#6: Establish the trend of the market you’re in and don’t go against it… You can read the full article here to explain this better.

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The moral of the story
Take economist’s Richard’s Thaler  “Endowment Theory” into not only your trading life but into your general life as well.
This theory applies to many examples…
Whether it be your business, investments, selling/buying online or your property.
Just remember to step out of your box and try to see the value of the products as they are, not what you feel they’re worth.
This way, you’ll eliminate your emotions and false feelings.
Trade what you see, see through the strategy, implement the strategy exactly. Don’t trade what you feel…
This will take you a long way!
If you enjoyed this article and you believe the “Endowment Theory” will help you, I’d love to hear by clicking here…

The “Endowment Effect” just may be the reason you'll fail as a trader
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