Loss Aversion

When it comes to the psychology of betting, a lot of focus is given to how we stop ourselves betting based on unhelpful cognitive biases.

Less attention is given to the corollary question: how do we make sure we act when we need to?

In their 1984 paper, Choices, Values, and Frames, Kahneman and Tversky demonstrated that human beings are hard-wired to hang on to things they own, even when they can be traded for things that are of a higher value. In other words, people generally prefer to avoid losses than to make gains.

Kahneman’s and Tversky’s findings have been of interest in the world of behavioural finance, where a phenomenon known as the disposition effect – where investors are less willing to sell shares that have fallen in value than they are to sell shares whose value has increased – is now well-established.

In a 1998 study by Terrence Odean, which looked at the trading habits of over 10,000 accounts held by a brokerage firm, investors were seen to have a significantly greater propensity to cash-in on shares that would return a profit than they were to cash-out on shares that would make a loss.

And it’s not just in the world of finance that humans exhibit these traits. The longer we’ve waited at a restaurant table for a blind-date, the harder it becomes to leave, as it feels as if the time we’ve “invested” would then be “lost”. The more we try to fit a new fridge through a too-small kitchen door, the less inclined we are to give up and accept that we need a smaller fridge. It seems that sometimes we will persist with a belief or course-of-action long after it is rational to do so: we feel trapped by what we have already committed.

Economists explain this cognitive bias as the sunk-cost fallacy.  If we’ve already invested in something, we feel as if we would be “wasting” resources by not following it through. It explains why entrepreneurs will continue to invest in products for which the market has expressed no interest; it explains why governments will continue to pursue policies that have proven ineffective; and it explains why a punter will keep backing a horse – race after race – no matter how many times it loses.

Loss aversion may seem inapplicable to gamblers.  After all, isn’t the whole point of gambling that we are prepared to lose money for the promise of future possible gain?

It might well be that there is something in the psyche of gamblers that means that we are less prone to this cognitive bias than the average person; however, many gamblers will recognise in themselves an unwillingness to close off a losing position.

If you backed a horse ante-post for the Melbourne Cup at $40.00, when would you be most likely to lay it?  If it shortened to $10.00? Or if it drifted to $60.00. Rationally, the decision should only be based on whether the odds at any given time represent value, and yet few punters would be emotionally able to cut their losses on a horse that drifts, no matter how compelling the case be that they should.

Take another scenario. You back three teams for the Rugby World Cup. Two get eliminated, leaving you with one finalist. Unfortunately, even if your remaining team wins, you will still make a small loss on the tournament as a whole. Are you tempted to back them again?

Loss aversion is also fascinating when examining the staking strategies of punters. Check out the articles elsewhere on this site about the Kelly Criterion and you’ll see that, far from being risk-loving creatures, we are possibly just as risk-averse as the next person: even when mathematics tells us that betting a large proportion of our bank is the right thing to do, we are unlikely to be able to bring ourselves to do it.

As with most things, it is likely that there is significant individual variation when it comes to our personal aversion to loss.  What’s clear, though, is that all punters need to be aware of these seemingly innate tendencies, as being irrationally averse to loss can lead us to lose much more (and win much less) than we need to.

About The Author – Jack Houghton 

As a passionate sports’ fan and punter, Jack has written about sports and betting for over a decade, winning the Martin Wills Award for racing journalism in 2002 and writing Winning on Betfair for Dummies, first published in 2006 and now in its second edition, having sold over 35,000 copies in two languages.

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