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What is Regret Theory, and How Is It Impacting Your Trading?

Rohanna Wise

Regret theory is a term being popularized in the currency community. Why now, and why in the currency markets?

More Nuance Than Traditional Economics

Traditional economics is based on assumptions around individuals behaving in a rational way, maximizing a utility function inside a set of constraints, rules, that are constantly being weighed and prioritized. But newer behavior economic theories and research into decision making is exploring how people make decisions when information or resources are limited, and how we are all biased. Important questions are being raised regarding how the human mind responds to making difficult decisions in uncertain conditions.

What is Regret Theory?

Regret theory is a part of this somewhat newer science.Regret theory centers on the fact that people are afraid of making wrong choices, and so the fear of regret drives suboptimal decisions. And regret theory works in both directions – making some people more risk-averse and protective, and others more aggressive due to ‘fear of missing out.’

How Are Portfolio Managers Managing Regret?

There are other ways to avoid or mitigate regret in currency hedging, or more broadly in investing in international securities. One is to do copious research and spend time trying to manage down risk by becoming an expert in currencies. However, in reality, portfolio managers need to be experts in stock selection, and very often don’t have or don’t want to spend time on acquiring the skills needed to apply currency trading expertise.

Some have suggested that a 50% currency-hedged portfolio may be the ‘hedge of least regret,’ as it allows for lower volatility in the more volatile markets, while still allowing for some upside – or downside. Every asset manager, and perhaps every portfolio manager, has a different policy when it comes to the management of this risk.

How WiseRisk Can Help

Once that decision is made, how is a manager to ensure that this policy is being followed up on – again, without having to constantly check markets and become a currency expert? This is where WiseRisk can help. With WiseRisk, you can choose what percent hedged you’d like to be. If that preference changes, you can trigger a manual rebalancing at the time you need to – or set rules about when the policy might change; for example, in times of greater volatility. We at Wise Trading Tech are here to help and answer your questions and implement your strategies to master those regrets.