Another behavioral bias that can be a challenge to traders is what we call ‘framing’ in NLP. Framing describes the natural tendency of humans to subconsciously feeling drawn to discounts. Let me give you an example: Last year I purchased a brand new high performance computer for my trading. The local computer shop offered the one that I had my eye on for $1450 and the computer superstore offered it for $1500. However, the computer superstore offered a $50 discount for paying cash whereas the local computer shop charged a $50 surcharge for paying with CC. Luckily I was aware how my brain would instinctively process the information as I had read the behavioral research that showed that most people would be inclined to buy from the place where they can get a discount even though both stores offer exactly the same deal: $1450 for cash and $1500 for paying with credit card.
Remember the brain takes processing shortcuts by selecting an initial reference point and then basing it’s decisions around that point.
Try it out yourself: what feels better to you, if I say, ‘this strategy has a 30% probability to lose money’ or ‘this strategy has a 70% probability to make money’. It is still the same risk reward in both scenarios, right? It shows that we evaluate outcomes in terms of profit and losses from the initial point they started the evaluation from.
So, the starting point in the superstore was $1500 and I was then offered a saving for paying cash. This felt for me like I had been offered a saving which is an improvement from the reference point. However, with the local computer shop the reference point was $1450 with a potential price increase for paying with CC which left me feeling like a change for the worse compared to my reference point.
The instinctive behavior that causes this way of evaluating is that we experience a certain loss as far more unpleasant than we appreciate a profit of exactly the same amount or as Steve puts it: ‘the pain of losing money is greater than the pleasure of making money’ and that’s why it is closely related to the much dreaded problem of loss aversion, where traders lose the most amount of money by trying to avoid a loss and on the other hand take their losses far more quickly.
Isn’t this bizarre when you consider that it’s all the same but instinctively we go with the one that we perceive to be a gain even if factually it is not?