Psychology to Survive Investment ③ - Tokyo General Research Institute -

Hello everyone!
We are the Tokyo General Research Institute staff team!

This is the second installment of the behavioral economics of investment, the latter part!

In the first part, we introduced cases where investment decisions fail.

In the latter part,we will explain the human psychology of gains and losses related toProspect Theory!

What is the "Prospect Theory"?

Prospect Theory models how people behave in risky situations when the choices of actions and the resulting utilities are known.

It may sound a bit difficult, right(in fact, when you try to explain it properly, mathematics comes into play and it becomes quite complex).

Let’s consider an example.

Suppose there is a game like the following

We flip a coin once.

If heads, you receive 1,000,000 yen

If tails, you pay 500,000 yen

(Assume the probabilities of heads and tails are 1:1)

Would you take on this game?

The expected average profit (expected value) is 25,000 yen, so rationally you would likely choose to take the risk.

From a psychological perspective, most people would not take this risk.

However, the essence is that, "People hate losing more than they like winning".

You might think this is obvious, but this fact explains most of the failures in investing.

Let’s return to the example from the first part.

In the case of person A.

At the moment they decided to take profits, they likely knew that the stock price could still rise.

Nevertheless, the reason A sold the stock was simply that they feared losing the gains they had already made.

The key point is that the fear of losses outweighs the expectation of gains.

As a result, they overestimated the possibility of incurring losses and made an incorrect judgment.

This tendency to prefer “securely securing profits and avoiding losses” stems from a psychological trait of humans that says “hating losses.”hating losses.”

What about the second case of person B?

In this case, unlike the first, the possibility of losses expanding is high, so a quick cut loss decision is rational.

However, for B, compared to a state where they had nearly 500,000 yen in profit, selling in the current declining price state feels like a loss, so they don’t want to admit it.

Because they think, “I hate losses,” they insist that they will surely rise again.

This psychology of “desperately trying to recover losses” ironically enlarges the losses.

In summary, about Prospect Theory,

・People hate losses

・They want to secure gains and avoid losses

・They become desperate to recover losses

that is what it means.

In conclusion

Prospect Theory, what did you think?

An important concept affecting the timing of asset sales.

To avoid falling into this trap, it is effective to think in terms of the absolute amount of assets rather than simple gains or losses (profit).

Rather than calculating how much profit (or loss) you would get by selling at this timing, think about how much assets would remain.

In any case, keeping in mind that this kind of psychological tendency exists will greatly aid investment decisions.

Thank you for reading until the end today as well.

Current ManagerIf you want to know about investment psychology,The Newslettersubscription has begun!

Titled“Market, Reading Behind the Scenes, Veteran Manager’s New Methods, Tokyo General Research Institute”!

Our representative will distribute insights on market outlooks and thinking methods using technical analysis.

From time to time, parts of paid content will be released for free, so please register enthusiastically!

Also,LINE@ provides real-time information as well.

If you don’t want to miss out on the flow of information, please sign up!

The Tokyo General Research Institute representativedelivers investment information via LINE