The Psychology Of Chance And Risk

Many psychology studies have examined human propensity towards uncertainty. The results depend upon the target group within the study. In the interests of fairness, a diverse population sample size should be included in any statistical research. Human behavior (particularly as it pertains to chance) is largely divided into three distinct groups:

Risk-seeking individuals tend to throw caution to the wind in pursuit of substantive gains in the short, medium, or long term. These folks often include other statistical data in their determinations, assessments, and decision-making processes. While statistics certainly tend toward the mean (the long-term average), wide variance is often a key factor in short to medium-term outcomes.

Longshot odds are powerful motivators for risk-seeking individuals. The prospect of outsized gains is appealing, despite the inherent risks. For the quintessential risk seeker, it’s all about anticipated gains. From trading to investing, risk seekers tend to project the future by betting on it in the present. A favorable outcome yields rewards, but unfavorable outcomes often provide invaluable experience. This serves as a powerful springboard to future success.

Indeed, we see this all the time with stocks, indices, commodities, forex, cryptocurrency, and options trading. Technical and fundamental analysis is used to create a rationale for investment decisions. Yet the unpredictability of the markets obeys no laws, precedents, or rational price movements. Ultimately, it’s a risk-seeking behavior in expectation of positive gains. In a sense, trading and investment decisions are similar to what a skilled blackjack player might expect at the casino.

Statisticians rightly point out that an astute blackjack player, for example, has better odds in a basic blackjack game than a novice investor has with the stock market. Both sets of individuals are seeking the best in windfalls. This is likely due to the known probabilities of outcomes in blackjack, as opposed to a myriad of unknown outcomes that can occur at a macroeconomic level. In fact, we might better compare the unknowns of the stock market to spinning on a slot like Captain’s Treasure. Why? Because, unlike blackjack, the “player” cannot affect the outcome. The stock market is no place for novices – that tip comes from experienced investors. It’s food for thought, nonetheless.

Risk-avoiding individuals have a near-zero appetite for placing faith in the unknown, with many caveats in tow. They prefer the security of bank-guaranteed returns with fixed interest rates for CDs, investments, and financial decision-making. It’s a case of slow and steady returns over the long haul, as opposed to a quick dash to the finish with the potential to trip up and hurt yourself.

Yet, even in such a scenario, risk-avoiding individuals routinely invest in the stock market through an employer, CFA, or broker in promising technologies, systems, corporations, et cetera. Often, an inherent sense of perceived stability versus perceived instability drives the behavior of risk-avoiding individuals. And yes, a risk-avoiding person will certainly frequent a casino, knowing full well that the best way to mitigate against risk is to set a strict budget and stick to it.

Risk-neutral folks understand that risk or chance is an intractable component of everyday life. Sure, you can reduce risk by following a predictable routine. But it’s virtually impossible to eliminate risk. Our propensity for risk is a product of our environment, personality, behavior, moods, etcetera. Risk-neutral individuals are neither against risk nor openly embrace it as their sole doctrine. It’s a fact of life, and it’s something that people deal with.

In the investing world, a risk-neutral individual is indifferent to risk when investment decisions are made. The focus shifts to the potential gains and not the possible losses. While they are fully aware of the risks entailed in any given decision process, it doesn’t become the sole focus of that person’s decision-making. A risk-neutral individual is inherently optimistic if there is the potential for a gain in a transaction – be it trading, investing, opinion-shaping, or even gambling.

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