Definition
Potential losses loom larger than equal gains, skewing exit timing and position bias.
Example
A trader holds a losing FX position long after the thesis has broken. Realising the loss feels psychologically worse than the economic impact, so the position is defended. Meanwhile, profitable positions are trimmed early to "lock in" gains, resulting in a skewed payoff profile.
Cognitive Driver
Losses produce a stronger emotional and cognitive response than gains. The avoidance of psychological pain becomes a priority, overriding objective assessment. The mind reframes decisions to minimise the chance of realising a loss, even when doing so degrades long-term outcomes.
Market Expression
Losing positions are held disproportionately long. Stops are widened or removed. Winners are reduced prematurely. Traders gravitate toward choices that avoid the immediate discomfort of loss recognition rather than those that optimise expected value.
Trigger Conditions
- Drawdowns or periods of negative P&L
- High market volatility
- Public or peer comparison of returns
- Situations where the trade is tied to identity or reputation
- Strong emotional investment in prior decisions
Diagnostic Markers
- Reluctance to exit after the thesis has clearly failed
- Early trimming of winners while defending losers
- Repeated justification for staying in losing positions
- Stop-loss removals framed as giving the trade "room"
- Discomfort or avoidance around marking positions to market
Cost Profile
- Negative skew in returns
- Large drawdowns caused by defended losers
- Systematic underexposure to high-quality winning trades
- Distorted risk allocation and capital inertia
- Reduced capacity to rotate into better opportunities
Differentiation From Adjacent Biases
- Not disposition effect: loss aversion is the pain-avoidance mechanism; disposition is the behavioural pattern it creates.
- Not sunk-cost fallacy: sunk-cost is about past investment; loss aversion is about the pain of realising losses.
- Not confirmation bias: loss aversion is emotional weighting; confirmation bias is evidence selection.
Corrective Lens
Reframe exits as capital redeployment rather than admissions of error. Use structured templates that explicitly compare the expected value of holding vs reallocating. When reviewing positions, require a forward-looking rationale independent of entry price to neutralise the emotional charge of marking a loss.