Tilt and Risk Management

I wish there were a flashing light to tell me when I’m on tilt.


A few things tend to happen when markets correct and intraday volatility increases as we’ve seen recently:

1. The mood of traders gets looser and more apt to change quickly and with wider extremes.

2. Traders becoming looser with their trades and actually take more risk.

3. Traders abandon their trading plans and neglect discipline (stops).

4. Traders add to losing positions.

This cluster of trader experience is symptomatic of the disposition effect within the domain of losses, more commonly called tilt.

The paradox of tilt is that traders (and poker players) increase risk seeking behaviors when losing money when the rational response would be to increase risk avoidance.

The problem with tilt is that we understand it well in hindsight it and we are often painfully aware of it as we are experiencing it – and yet our awareness of it does not prevent the irrational trading behaviors.

You may read posts telling you what to do in these situations. Writers will give advice like, “lighten up positions” or “trade less.”

The truth though is that the advice is obvious and does not help.

Awareness is not really the issue. The tendency to respond to losses by increasing risk seeking behaviors has a bioligcal basis. It is hard wired and so friendly advice is no match to the compulsion.  Traders already know what they should do and yet they still don’t do it.

You may not have the tendency in which case you are rationally abnormal.

You may have uncommon discipline which serves you well.

More likely, you may have learned from previous experiences when lightening up served you well despite your wish to dig deeper into the hole. In these cases you were positively reinforcing rational behavior and extinguishing the irrational compulsion.

If you are on tilt, I have no cheap advice for you.  You will deal with it how you will and either gain, minimize losses or get dinged pretty good.

Ultimately, the choice is yours…

Photo via Flickr and Courtesy of Paul McRae