In plain terms, mental accounting is derived from the term ‘mental accounts’ which refers to some people’s method of categorizing money in different capricious classifications and based on those classifications, they decide on the best ways to spend their money.
This effect can be understood by the following example; say, a thirsty juice drinker is willing to pay $8 for a bottle of juice when he’s on vacation - he will automatically put this consumption in the ‘beach holiday’ mental account, now he might be hesitant to pay the same amount of money for juice at a supermarket because it would be going under his ‘supermarket expenditure’ mental account.
Therefore, we can conclude that humans have a tendency to place certain events into mental compartments, and the difference between these compartments sometimes impacts our behavior toward the events much more than the events themselves do.
Mental Accounting in Forex TradingAt times, investors might be hesitant to sell an investment that once had huge profits attached to them but now have only minimal gains up for grabs, during an economic boom, people tend to get accustomed to plenty of profits and when the market correction deflates investor's net worth, they're more cautious when selling at a smaller profit margin. They create mental compartments for the gains they once had, causing them to wait for the return of the same or more amount of profit.
Advantages and Disadvantages of Mental Forex AccountingNeedless to say, mental forex accounting has the potential to be harmful to the trader as when the trader is constantly subconsciously categorizing all the money he might be making through trading, he might be restricting himself from making use of the money in ways that he wishes to. For example, it might cause the trader to classify inherited money in the ‘windfall revenue’ mental account and would choose to spend it more liberally than the money they put under their ‘paycheck’ mental account, in this way traders tend to treat their money with discrimination while investing.
However, mental accounting can be a resourceful tool if used properly, as it may help the trader achieve certain investment goals that he might have set for himself, for example, through mental accounting, the trader might have put some money aside for retirement that he could have used up in a trade. This is especially helpful to the forex traders because it’s tempting to simply use up all the money in trading but mental accounting helps them refrain from risking unnecessarily large amounts of money and having something to fall back on in case they go bankrupt. Mental forex accounting is almost like the sub conscience way of providing a sort of insurance policy.
In conclusion, mental forex account is undeniably a smart method of properly managing your money as a trader and understanding what money belongs where, rather than seeing it all as something that can and should be risked on trade. However what the trader must remember is that no matter what mental account you put a certain amount of money in, there will be no impact on your wealth, because mental accounts are just that- mental.
