Trading Psychology
Prospect Theory — Definition & Example
A behavioural-economics framework explaining how people evaluate gains and losses asymmetrically under uncertainty.
Developed by Kahneman and Tversky in 1979, prospect theory shows that people evaluate outcomes relative to a reference point (usually status quo) rather than in absolute terms, and that they're loss-averse by roughly 2:1. The theory explains many trading behaviours — risk-aversion in gains (premature exits), risk-seeking in losses (averaging down) — that classical finance can't. Awarded the 2002 Nobel Prize.
Example
A trader given a coin flip for "₹5,000 win or ₹5,000 loss" usually declines (loss-aversion). The same trader, already down ₹5,000, will often take a coin flip for "double-or-nothing" because in losses, people become risk-seeking — the textbook prospect-theory result.
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