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Regret Theory Definition
Regret can be defined as a negative emotion with a great influence on the social and reputational components and is key to how humans learn from experience, and to the psychology of human risk aversion. In regards to this, the regret theory or anticipated regret states that if people make a wrong choice, they anticipate regret and consider this regret during any form of decision making in order to reduce the possibility of the occurrence of one; or even totally eliminate the probability of the risk occurring. The fear of regret can play a crucial role in discouraging a person from taking part in an action or encouraging a person to take part in an action.
A Little More on What is Regret Theory
In the process of investing, an investor can either be risk-averse, i.e., afraid to take risks or he can be risk-tolerant, i.e., he is an opportunist who can take great risks. Taking an example of an Investor A who buys stock solely based on his friend’s personal recommendation from a small growth Company B. After a period of six months, there is a fall in price of the stock to say, 50% of its purchase price; which makes Investor A sell off the stock and incur a 50% loss. Investor A will make necessary research and ask questions on any stocks his friend suggests in the future, in order to avoid regret; and vice versa.
Regret Theory and Psychology
If investors are aware and equipped with the knowledge of the psychology of the regret theory, they can make informed investment decisions and reduce the anticipation of regret manipulating their investment decisions. There is an urgent need for investors to analyze the influence of regret on their past investment decisions and make use of it when deciding on a new investment opportunity. For instance, an investor may have subsequently traded only momentum stocks while trying to catch the next significant move because he missed a large trending move in the past. It is necessary for the investor to realize that he tends to consider regretted missed opportunities and consider before choosing to invest in the next trending stock.
Regret Theory and Investment Process
A strategy like a formula investing can help investors to minimize their fear of regret which had risen from bad decision making. The formula investing strategy automates the investment process by only following the specified rules which are used for making investments. It eliminates a majority of the investors’ decision-making process which includes, what, when and how much to buy. Investors’ trading strategies can be automated and the utilization of algorithms for execution and trade management is encouraged. The probability of an investor making investment decisions based on his personal judgment due to a past investment outcome can be reduced by using the rules-based trading strategies. Investors can also be alerted about possible personal bias errors by backtesting automated trading strategies.