You are as timid as a mouse when making profits, but fearless when facing losses. Nobel laureate Daniel Kahneman revealed in “Thinking, Fast and Slow” that your brain maintains psychological balance by creating a cheating “mental account,” systematically deceiving yourself and preventing rational stop-loss decisions. This article is based on an essay by CryptoPunk, organized, translated, and written by PANews.
(Previous summary: Black Swan author’s new paper: Is avoiding stop-loss safer? The hidden structural risks behind it)
(Background supplement: The first rule of trading: Discussing clear risk control and position stop-loss)

Table of Contents

• Introduction: Systematic Self-Deception
• Part One: The “Downgraded” Money
• Part Two: Biological Instincts During Losses
• Part Three: Any “On-the-Spot” Stop-Loss Requiring “Real-Time Decision” Is Ineffective
  • 1. Only “Hard Stop-Loss,” No “Psychological Stop-Loss”
  • 2. Implement “Overnight Circuit Breaker”
  • 3. Redefine “Principal”
• Conclusion

Introduction: Systematic Self-Deception

Stop talking about technical analysis or macroeconomics. The fundamental reason you are still the “liquidity” being harvested is only one:

You are as timid as a mouse when profitable, but fearless when losing.

Seeing a 10% unrealized profit, you panic, fearing the duck cooked and flying away, quickly taking profits; seeing a 30% unrealized loss, you become calm, closing the software, telling yourself: “As long as I don’t sell, this isn’t a loss.”

This is not a good mindset. From a cognitive science perspective, this is a form of systemic self-deception.

Nobel laureate Daniel Kahneman already provided the verdict in “Thinking, Fast and Slow”: your brain, in order to maintain a certain psychological balance, has set up a cheating “mental account” for you.

Part One: The “Downgraded” Money

Why are you reluctant to stop-loss? Because you live in an illusion woven by your brain.

In the background of your mind, there are two ledgers:

2. Reality Account (Cash): Money used for groceries, meals, rent.
3. Psychological Account (Holdings): The money here is defined by you as “game tokens.”

This explains why losing 100 dollars in real life makes you upset for a long time, but witnessing the evaporation of tens of thousands of dollars in market value on trading software leaves you indifferent. Because on a psychological level, this money has already been downgraded by you.

When the account shows a loss, your brain activates the “isolation mechanism”: as long as you don’t close the position, this loss is just pixels on the screen, “floating,” “fake.”

The difficulty of stop-loss lies in forcing you to break this isolation, turning “floating loss” into “real pain.” To avoid this settlement, you choose to bury your head in the sand like an ostrich, maintaining this false psychological account from collapsing.

Wake up. There is no “floating loss” in the financial world; every second’s market value is your current net worth. Not selling is itself a new buying decision.

(Note: This article discusses only one core proposition — when trading is already unfavorable to you, why does human instinct push you toward worse decisions? We do not discuss fundamental reversals or systemic holdings, only judge irrationally holding on based on escape psychology.)

Part Two: Biological Instincts During Losses

Kahneman’s prospect theory reveals a harsher truth: humans’ attitude toward risk is schizophrenic.

• Profit: You become extremely risk-averse.
• Loss: You become extremely risk-seeking.

Faced with a -20% loss, rationality tells you to cut your losses and exit. But your animal instincts tell you: “Go for it! Hold on a little longer, maybe you’ll break even!”

Once you enter the loss zone, your brain no longer serves “maximizing returns,” but “avoiding admitting mistakes.”

Here, two completely different behaviors must be distinguished: one is based on pre-set rules — “strategic floating loss”, and the other is based on post-loss emotional stubbornness — “emotional holding on.” This article aims to judge the latter.

In the quagmire of losses, to avoid certain losses, you are willing to stake your entire net worth on a tiny chance of breaking even. At this point, you are no longer a rational trader; biologically, you have entered a typical “loss chasing” state.

Part Three: Any “On-the-Spot” Stop-Loss Requiring “Real-Time Decision” Is Ineffective

If you’re still thinking: “Next time, I will rely on willpower to stop-loss,” congratulations, you will still blow up your account next time.

In a trading moment with adrenaline surging, trying to use “willpower” to fight the millennia-evolved biological instincts is itself arrogance.

Want to survive? You don’t need stronger willpower; you need a set of rules that require no willpower.

1. Only “Hard Stop-Loss,” No “Psychological Stop-Loss”

If you are still using your brain to remember stop-loss levels, you are leaving yourself a way out. Solution: When placing an order, set a conditional order. Delegate the stop-loss to the exchange’s server, not your finger. If you are afraid to set a stop-loss order, it means from the moment you opened the position, you were already prepared to be an ostrich.

2. Implement “Overnight Circuit Breaker”

Most big losses are caused by the obsession of “not wanting to carry losses overnight,” leading to deeper and deeper traps. Solution: Set a strict rule — before market close (or before sleep), if the account is in the red, unconditionally close half of the position.

(Note: This strict rule is specifically for two types of people: 1. Subjective traders without thorough backtesting; 2. Those already showing obvious emotional fluctuations during losses. Trend-following systems are not in scope.)_

Why is this critical? Because continuity fuels gambler psychology, and the essence of circuit breakers is to cut off this continuity. Once the flow of time is broken, your brain can switch from “recovery mode” back to “rational mode.”

3. Redefine “Principal”

Forget your deposit amount, forget your cost basis.

Solution: Before each market open, write down your current net assets on paper. This is your principal today. If it’s only 50,000, think in terms of a 50,000 position. Never try to recover “money already lost,” because that money physically no longer belongs to you.

Conclusion

The market is not only a wealth transfer arena but also a meat grinder of human nature.

Stop-loss, in essence, is an anti-human “detox.” It goes against our pursuit of perfection and wounds our pride of not wanting to admit defeat.

But remember: Your brain is designed for survival, and the market is designed for harvesting.

The market never rewards instincts, but it leaves a channel for the few who are willing to self-discipline.