Marcus Padley writing on share trading in the Melb. Age makes some good points that are as true for share traders as they are for punters [just read 'punter' instead of 'trader' as a trader is on the punt too, just a different market]:

Why do so many people lose at trading? The answer is that they are humans not machines. Most traders do not think clearly and, faced with losses, gains, luck and indecision, they begin to function emotionally instead of mechanically. It is this weakness the studied professional trader takes advantage of.

Identifying common behavior patterns that lose you money. Here's a list of some of the more common ones. In financial and social theory some of these are called cognitive biases, erroneous rules of thumb or common errors of judgment. In trading there are many. You might recognize a few of your own:



■Emotional bias — the tendency to believe the things that make you feel good and to disregard things that make you feel bad. In trading terms this means ignoring the bad news and focusing on the good news. It's called losing objectivity. You don't recognize when things go wrong because you don't want to.

■Expectation bias — the tendency to believe in things that you expect. In financial terms this means not bothering to analyze, test, measure or doubt the conclusion you expect or hope for. It is also known as the law of small numbers. Believing in something with little real evidence.

■The disposition effect — the tendency to cut your profits and let your losses run. The complete opposite of what a trader should be doing. Making small profits and big losses is a recipe for losses.

■Loss aversion — the tendency to value the avoidance of loss more highly than the making of gain. Losses affect you more than gains. Because of this you become more emotional when making losses, the point at which a rational decision would save you the most money.

■The sunk cost fallacy — this is the tendency for our decision making to be influenced by the size of the loss we have already incurred. The bigger the loss the more likely we are to persist with a losing trade rather than to take the rational decision and cut to a more profitable trade. The size of your loss has no effect on the future share price but a huge effect on your ability to make the right decision.

■The bandwagon effect — the tendency to think it must be right because everyone else is doing it. A thought process guaranteed to get you in when it's obvious and get you out when it's obvious. Put another way, it has you buying at the top and selling at the bottom.

■Past price fixation — this is the tendency to avoid prudent trading decisions by anchoring your thought process to prices that no longer exist. "I'll sell it if it gets back to $4." "I'll buy it if it gets down to $4 again." We are all guilty.
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Crash: I'll put my hand up to a few of these. Not as many as once upon a time, but I still fall into the emotional traps now and then.