Gambling with the House Money and Trying to Break Even: The Effects of Prior Outcomes on Risky Choice
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What they found
Thaler and Johnson ran experiments to see how a prior gain or loss changes people's willingness to take the next risk. After a gain, subjects became more risk-seeking (the 'house money' effect: recent winnings do not feel like your own money). After a loss, subjects were generally more risk-averse, except when a gamble offered a chance to get back to even, in which case they became risk-seeking (the 'break-even' effect). The paper shows that how people edit and frame sequences of outcomes, not just the outcomes themselves, drives risk-taking.
What you can use
- After a big winning trade, you will be tempted to size up because the profit does not feel real; the research says this is systematic.
- After a loss, the chance to 'get back to even' makes people take gambles they would otherwise refuse; that is the revenge trade.
- Set position sizes in advance, because your risk appetite after wins and losses is not the one you would choose on a calm day.
Caveats
Laboratory gambles with modest stakes; the exact mix of house-money and break-even effects varies across studies. Not a study of real trading.
Tags: behavioral, house-money, break-even, risk-taking
Summaries are our own reading of the paper, not the authors' words. Educational only, not advice. Discuss it in Book Club.