Tuesday, April 20, 2010


Psychologists have studied what makes people happy. They have found that when it comes to winning and losing money, or positive and negative events, that people prefer to have positive, or winning events, on a constant basis, and negative, or losing events, in “one shot,” rather than spread out.

For example, more happiness is derived from winning $1, one hundred times, then winning $100, one time. Constant winnings matter. Interestingly, it has also been found that the size of our winnings generally does not matter. The frequency of our wins is more important in creating overall happiness. Conversely, people also prefer to have negative events occur in one shot, rather than spreading them out over time. So it is better to lose $100 one time, than to lose $1, one hundred times.

How does this relate to trading? The answer is that these concepts need to be considered BEFORE we build trading models. I find the psychologists’ results interesting because some traders do not think about what makes them happy before they build their trading models. We know that the frequency of our wins and losses will affect our happiness. Nonetheless, daytraders research and calculate their historical statistics, and if the model is profitable, they go ahead and trade it without considering how frequently the profits occur. Some daytraders use models that lose a majority of the time and rely upon large, and less frequent wins. Others build models that win more frequently and lose less frequently.

The trading models I use fit my personality. I, for one, do not like to lose frequently, thus my models’ historical statistics show a larger percentage of wins to losses. The drawback to this is that my average losses are larger than my average wins, but my losses occur less frequently. These results fit well with the findings of psychologists. My big losers tend to occur in one shot, and less frequently, than my winning trades. Losing trades is part of the game of trading, but how we lose, and the frequency of our losses is even more important to our general happiness.

In conclusion, my suggestion is that it is very important to know what makes you happy before building your trading models. Daytrading is very difficult and traders would do better if they consider what psychologists have understood about happiness. The frequency of positive and negative events matter in our lives, and in our level of happiness in regards to trading.

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