Status quo bias in trading

Status quo bias in trading

Status quo bias refers to the tendency of individuals to prefer the current or existing state of affairs over alternative options or changes.

It is a cognitive bias that influences decision-making and leads people to maintain or stick with their current choices, even when objectively better options or alternatives are available.

Research about status quo bias

Numerous studies have been conducted on status quo bias, with many of them sharing similarities and having straightforward designs.

All of these studies provide evidence that confirms the existence of status quo bias.

What these studies essentially did was select a group of people and present them with a product.

They then asked whether they would prefer to change that product for another option. The findings consistently showed that the majority of people chose to stick with their initial product and did not opt for a change.

Subsequently, they formed different groups and presented them with a range of multiple products to choose from. In this scenario, people made diverse choices, opting for different products from the available options.

So, In the first group, when participants were given a product and asked if they wanted to exchange it for any of the multiple products, they showed a reluctance to change and preferred to stick with their initial choice.

However, in the second group, where participants were not given any specific product initially and were presented with multiple options to choose from, they made varied choices and selected different items.

Their findings revealed that as the number of choices increased, the strength of the status quo bias became more prominent.

When presented with only two choices, people were more likely to switch from Option A to Option B. However, when faced with a larger selection of 50 choices, individuals exhibited a preference to remain in their current situation rather than make a change.

The question arises: why do we exhibit this behavior? Is it because we genuinely prefer our initial or current situation?

No!

The underlying reason for our preference to remain in our current state is rooted in the fear of losing what we already possess or experience in our present situation.

We are reluctant to give up what we already have.

So It’s coming back to Loss Aversion, where the perceived pain of losing something is so significant that we are motivated to avoid experiencing that loss.

The majority of individuals prefer to stay where they are not primarily because they are afraid of going somewhere else, but rather because they are afraid of losing what they currently possess.

How status quo bias affects trading?

Once you find yourself in a particular position, the inclination is to remain in that position despite the presence of opposing facts or evidence.

This tendency is understandable since the abundance of thousands of options to choose from makes it incredibly difficult to depart from the current position.

Consider an individual who purchases a stock, but its value begins to decline. Despite the downward trend and the stock remaining stagnant for several months, that person continues to hold onto it.

How can this behavior be rationalized? Why would someone persist with a stock that has been performing poorly, especially when there are approximately 8,000 other stocks to select from? He is just carrying dead money.

The logical course of action would be to exit that stock and transition to another one. However, people often choose to stay invested in it, believing that it will eventually recover and generate profits in the near future.

Their attachment to that particular stock is not driven by a strong preference or affinity for it.

Rather, it stems from the fear of missing out on potential gains if the stock were to increase in value.

They anticipate that if they were to exit the position and the stock subsequently surges, they would experience emotions such as pain, regret, and self-blame.

To evade these negative emotions, they opt to remain in the position, resulting in an extended holding period where they may not make any profits or potentially even incur losses.

This situation arises due to their inability to change their current situation and transition into alternative investments.

It is Human Behavior.

It is important to acknowledge that we are all prone to this bias, where we tend to prefer staying in familiar situations and find it challenging to make changes.

However, it is crucial to push oneself beyond the comfort zone and be open to change.

To overcome this bias, one must actively strive to break free from the status quo and be willing to embrace new opportunities, and make necessary adjustments.

In order to counteract this bias, we integrate the notion of “Holding Time” as a parameter within our trading plan.

By setting a specific timeframe, we establish a predetermined duration for holding a position. Once this timeline has elapsed, regardless of whether the position has resulted in a gain or loss, it is required to exit the position.