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Endowment Effect Solutions

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A hat tip to friend Denise Shul, a leading neuro scientist and trading coach in New York, for pointing out a recent academic research paper which I will be commenting on in this letter.

I am sure we can all agree that when we buy something for say $10, we are unlikely to want to sell it for the same price a few moments later. We tend to want to sell something we own for more than we paid for it. Here is another spin on the same idea; when we consider the valuation of an item, we tend to place more value on the item when we own it than we would on the same item if we didn’t own it. What I am describing is what psychologists and behaviour economists call the Endowment Effect. The difference in perceived value based on ownership is not rational.

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Research Findings

Professors Ali Hortacsu and Howard Nusbaum, researchers from the University of Chicago, found that by getting inexperienced traders to partake in selling items on eBay for a period of 2 months, they noticed that there was less activity in the area of the brain that is associated with pain and negative emotions.

This follows on from findings by researchers that already established experienced traders exhibit less brain activity in the area of the brain that measure pain and negative emotions and are therefore less prone to exhibit the endowment effect in their trading. What is so encouraging by this finding is that according to Professor Nusbaum getting someone who is inexperienced to do as little as 20 trades on eBay can change their neural pathways to match someone who is a professional trader.

PsyQuation Takeaway

I found this research tremendously encouraging for traders who genuinely want to become better at their craft. We all know there is no substitute for experience. This study however gives us hope with the ability to “oven blast” certain aspects of our experience development.

What the study further highlights is that in order for a trader to improve, he/she needs to learn from an expert who is not as prone to biased behaviour and in so doing, in a short space of time, you will be able to shape your neural pathways to display less evidence of biases such as the endowment effect.

I guess we could say from this research that practising on a demo trading account will be helpful for gaining experience. However, I still feel that trading a demo account does not translate to the full emotional experience and therefore I am not convinced it has the ability to shape neural pathways with the desired effect.

I would encourage an inexperienced trader to start trading with a small account, this way you will become psychologically engaged, creating enough emotional neuro activity to make a meaningful difference. Of course this is all worthless if you do not have a way to check your trading to ensure that you are trading with as little bias as possible. I believe this is where PsyQuation has such a powerful role to play with traders. Our software has the ability to identify areas of weakness where you are displaying bias and in turn making trading mistakes. By correcting these mistakes identified by our red alerts and following the path where our green alerts give positive reinforcement feedback for tracking along a stable path I am very hopeful that PsyQuation will play a meaningful role in the profitable development of many of its traders.

 

 

 

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