Terrance Odean once wrote a scientific research paper that was published in The Journal of Finance back in 1998. It is called Are Investors Reluctant to Realize Their Losses? The article's main topic is the disposition of traders to close their winning positions early and keep their losing positions longer. In that particular case, they are stock traders dealing through a discount broker during 1987–1993.
To save you a few hours of reading through the terms like "heteroskedasticity", the main results and findings of the research conducted by Odean are presented below.
There are two points in his hypothesis:
To prove his point, Terrance calculates the amount of realized gains, realized losses, paper gains, and paper losses for each day when any of the 10,000 study accounts has a trade closing. Then, Proportion of Gains Realized (PGR) and Proportion of Losses Realized (PLR) is calculated using the following formulas:
The resulting PGR and PLR are numbers between 0 and 1. The closer the number to 1, the higher proportion of position closing occurs. If PGR is higher than PLR, then traders close winners more frequently, leaving more losses on paper.
For the whole data set, Odean finds that PGR = 0.148, PLR = 0.098 with a difference in proportion of -0.050, which means that traders prefer to cut their winners short and let their losses run. The author's research also proves that such skew in behavior is not a result of:
Although one may say that the stock market of the late 80s and early 90s has little to do with the modern online currency trading, it is important to note that the main finding of Odean's paper lies not in the field of finance but rather in the psychology of trading. It seems to me that the majority of FX traders still hang on to their losing positions and try to close the profitable positions as soon as possible. That is why many prefer to trade without a
A great thing about this article is that everyone can use the presented methodology to count their own PLR and PGR values. If you have your trading journal or a trading platform report, you can calculate your proportions of realized gains and losses. It will take about 1–2 hours, depending on how frequently you traded and how you will automate the calculation process.
For example, let's consider a trader who analyzed 88 trades for a period of 5 years. The resulting Proportion of Gains Realized (PGR) was 0.45 and Proportion of Losses Realized (PLR) was 0.46. The low difference in values could be explained by low frequency trading (rarely more than one position open simultaneously). Still, a slightly higher PLR points out that, unlike the traders from the Odean's study, the losses were closed a bit faster than the winners were cut. Though, it doesn't say anything about the trader's overall profitability.
If you have any questions or comments about traders' disposition to keep losing trades and to cut winning ones or if you want to share your own PLR/PGR calculations, you can do so in our Forex forum.
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