Imagine you have been invited to take a bet on a coin toss – heads or
tails. If you call incorrectly you lose $100. How much would you
want to win, if correct, in order to take the bet?
This is a question from research in behavioural finance that I often ask in
my trading psychology workshops. The most popular answers are between
$101 and $300 (the market makers, scalpers and high-frequency traders
looking for multiple plays at the $101 end of the spectrum; the directional
traders with their 2:1 or 3:1 risk-reward ratios at the $200–300 end).
Occasionally a few people come in at around $500, with the odd person at
$1,000.
Research into loss aversion suggests that, in the example above, on average
people want to win around $200.
That is, they would like $200 to offset the risk of losing $100, such that $2 of pleasure is needed to offset every $1 of pain.
Flipped around: the pain of loss is twice the pleasure of winning.
Extract from Bulletproof Trader – Steve Ward
