*****David Blair, The Crosshairs Trader, is a blogger/trader/educator who does a wonderful job of sharing research on elite performance and how it relates to trading. Below is his latest post for the SMB trading community.***** — Editor’s Note

Whether we believe it or not we tend to choose different options for the same problem depending on the way the problem is presented and whether or not the problem is presented as a loss (negative) or a gain (positive).  This is known as framing and is just one of many cognitive biases we face in our day to day decision making.  As an example, let’s suppose a physician informed you that a suggested surgical procedure has a 95% survival rate and will require several months of strict adherence to a rehabilitation protocol.   You consider this to be pretty good odds when framed in the positive (95% success rate) and when you are more than willing to dedicate the time required for recovery.  But what if the physician informed you that the procedure is complicated, will require months of disciplined rehabilitation, and there is a 5% chance you will not survive the procedure?  When framed in the negative we tend to make different decisions even though the odds of failure are the same (5%) in both cases.

And how about the stock market?  How does framing affect our decision making process when considering taking trading risks?  If you were to read where a particular chart pattern is profitable 72% of the time over the last 20 years (positive framing) you would most likely consider that to be pretty good odds.  However, if another study reveals that when this pattern does not work the percentage loss is much greater than the potential gain (negative framing) would you still be comfortable with the odds?  What if you found that trading the false move (the 28% of the time) would have been more profitable?  How would you feel then?

What about the financial headlines?  Our thinking is easily susceptible to framing every single day when we read headlines such as “Gold Sells Off As Ukrainian Tensions Ease” which implies that gold is weak because of easing Ukrainian tensions.  We may then make our gold related trading decisions based on Ukrainian tensions only to find the next day’s headline reads “Gold Sells Off In Spite of Heightened Ukrainian Tensions”.  So, now gold weakness is not related to the Ukrainian crises?  You get the idea.  It is all in how you frame it.

The following  articles will help you along the way to building the appropriate understanding of, and proper respect for, how the framing effect can influence your trading decisions.

“The way a question is ‘framed’ often has an influence on how people answer that question.”

“Explanations and predictions of people’s choices, in everyday life as well as in the social sciences, are often founded on the assumption of human rationality.”

“The way in which a problem is presented will have an influence on the way that a individual reacts to the problem, which in turn will change the way in which this problem is perceived.”

“The language used to describe options often influences what people choose.”

“Overall, the evidence for the effect of framing on risky choice reveals a relatively consistent tendency for people to be more likely to take risks when options focus attention on the chance to avoid losses than when options focus
on the chance to realize gains.”

“For years, behavioral finance researchers have been aware that people’s decision making is greatly affected by how choices are framed.”

“The point is that decision making is rooted in people who have diverse values and capabilities that affect the choices they make.”

David Blair

THE CROSSHAIRS TRADER
www.thecrosshairstrader.com

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