Compliance, Ethics & Behavioral Finance·Behavioral Finance
Prospect Theory & Loss Aversion
Why losses hurt twice as much as gains feel good
Prospect Theory, published by Daniel Kahneman and Amos Tversky in 1979, replaced the rational-utility model of classical economics. People do not value outcomes by absolute wealth — they evaluate gains and losses relative to a reference point. They are roughly twice as sensitive to losses as to equivalent gains (loss aversion), and they overweight low-probability events and underweight high-probability ones (probability weighting).
Loss aversion in trading
Loss aversion is why traders cut winners early ('lock in the gain before it goes away') and let losers run ('it'll come back'). The behavior is symmetric to the bias and predictably destroys edge. The discipline of pre-committing to stops and targets is a structural defense against it.