Poor risk assessment often leads to catastrophic trading and investing decisions. We buy too many shares of our favorite stock; we enter option positions without knowing how much money is at risk; we ignore our own stops and double down; we get margin calls during market meltdowns and sell at very low prices. The resulting losses become a trap on the way to failure.

The stock market has been in a strong bullish trend for five years. If you have a bullish portfolio, perhaps you have not experienced severe losses or perhaps the memory of plummeting prices has faded. But whether the market is trending up or down, and whether you are bullish or bearish, understanding risk is essential for long-term success. Unfortunately, experience has not taught most of us to accurately evaluate probabilities and risks.

Typically, we learn basic math at school and focus on "certainty" math. Our "math brains" develop in a world of definite outcomes, where 2 plus 2 is 4, and 7 minus 1 is 6. We don't need to explore the likelihood that something will go wrong and 7 minus 1 will equal something else once in a while.

In this next article, Morgan Housel discusses how we habitually underestimate real risks while over-emphasizing obscure risks. This flaw in our grasp of uncertainty shows up in many areas from beliefs about medicine, to fears of wolves and sharks, to ill-fated trading decisions.

How to Scare Yourself Stupid

By Morgan Housel at Motley Fool 

Excerpt:

Ebola has also been in the news this week, scaring people around the world. Ebola has killed 1,590 people since it was identified in the 1970s, according to the World Health Organization. Measles -- which faces a vaccination backlash -- kills about as many people every 96 hours.

The craziest thing about risk is that people fear what's rare and unknown much more than they fear things that are common but deadly.

Why?

Gigerenzer writes:

People aren't stupid. The problem is that our educational system has an amazing blind spot concerning risk literacy. We teach our children the mathematics of certainty -- geometry and trigonometry -- but not the mathematics of uncertainty, statistical thinking. And we teach our children biology but not the psychology that shapes their fears and desires. Even experts, shockingly, are not trained how to communicate risks to the public in an understandable way. And there can be positive interest in scaring people: to get an article on the front page, to persuade people to relinquish civil rights, or to sell a product. All these outside causes contribute to the problem.

Several other causes contribute to the problem of what I'd call scaring yourself stupid.

Full article: How to Scare Yourself Stupid

Picture credit PublicDomainPictures at pixabay.com.