Saturday, February 28, 2009
What is Frame Dependence and how does this seemingly "bombastic" term seem to relate to my own investing/trading decision ?
Frame Dependence is a big topic and can be related in many ways but what I attempt to do here is to simplify the entire concept for easier understanding, not that I understand everything about it but this is just for sharing.
<--- Before you start going further, image your brain as a box.Frame Dependence is made under both emoitional and cognitive reasons. The cognitive aspects refers to the way people organize their information while the emotional aspects deal with the way people feel when they register their information.
The term frame dependence means that they way people behave depends on the way that their decisions are framed.
Think about this: When stock prices go up, dividends can be savoured separately from capital gains but when stock prices go down, dividends serves as a "silver lining" for the capital losses.
Think about this example.
Let's say you've already won $1,500 and there is a chance to make another $500 or lose another $500. Some people will see themselves as $1,500 ahead whereas some will "feel" the loss of $500 when faced with this choice.
This difference affects a trader/investor's behavior : Because of Loss Aversion, people who ignore having profited that $1,500 are less prone to accepting the gamble then those who see themselves as $1,500 ahead. This is also known as the "House Money Effect".
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