How trading shocks shape risk preferences: nonlinear evidence from retail forex traders

PurposeThis paper addresses the conflicting views on whether traders become more risk-averse or more risk-seeking after experiencing trading shocks. It aims to uncover how the magnitude of prior gains or losses influences subsequent risk-taking behavior in retail trading.Design/methodology/approachUsing over 349,000 daily retail trading records, the study classifies trading shocks into 18 levels and examines their lagged effects on traders' risk-taking behavior, measured by leverage.FindingsTraders' responses to prior shocks exhibit clear asymmetry. After small shocks, whether gains or losses, traders become more risk-averse. In contrast, after large shocks, especially gains, they become increasingly risk-seeking. These effects scale with shock levels and fade over time. The switching point between risk aversion and risk seeking lies deeper in the loss domain.Practical implicationsBy revealing nonlinear post-shock risk preferences, this study suggests design opportunities for trading platforms, such as nudging tools to prevent excessive risk-taking after large shocks. It also informs risk management systems that aim to reduce over-leverage during volatile periods.Originality/valueThis paper introduces a detailed framework for analyzing aftershock risk preferences, offering a behavioral explanation for previous mixed findings. It contributes to the literature by revealing a nonlinear, asymmetric pattern in how risk preferences respond to shocks.