Disposition effect

Do you tend to hold onto stocks long after they’ve started dropping in value, and try to make up the loss by selling other stocks soon after they’ve increased in price? This could mean selling “winning” investments too soon and holding on to “losing” investments for too long.

Overcome behavioural biases to reach your investing goals.

Research shows that we tend to attach more importance to avoiding losses than acquiring gains. For example, imagine that you won $100 in a raffle. Now, imagine that you won $200 in a raffle, but $100 fell out of your pocket and got lost later in the day. Which scenario would leave you feeling happier at the end of the day? Most of us would feel much better about option “A,” even though both optionsOptions An investment that gives you the right to buy or sell it at a set price by a set date. The buy right is termed a “call” option, and the sell right is termed a “put” option. You buy options on a stock exchange.+ read full definition leave us $100 richer at the end of the day.

These feelings can influence us when we investInvest To use money for the purpose of making more money by making an investment. Often involves risk.+ read full definition. If you hold an investmentInvestment An item of value you buy to get income or to grow in value.+ read full definition that’s been losing money over a long period of time, you might put off selling that investment, because you don’t want to “admit defeat” by realizing the loss. But when your investments gain in value, you might be tempted to sell these investments early to “lock in” the gains you’ve made, and pass up opportunities for additional gains in the future. You may even sell our winning investments in an effort to “make up” for the money you’re losing on other investments.

When you do this, you could feel like you’re maximizing our savings, but you’re actually doing the opposite. In short, “holding on to losers, but selling winners” isn’t a winning strategy.

You can avoid this tendency, called the “disposition effect,” by making sure your investing decisions aren’t just based on gut reactions or emotions. This starts with understanding your risk profile and how much loss you are willing to tolerate before you buy an investment.

Before selling a “winning” investment, remind yourself why you bought it in the first place and consider whether it still aligns with your investing goals. Ask yourself if you are selling to compensate for a “losing” investment that you continue to hold. Your financial plan can help you decide if you are making the right choices.

Remember that the stock marketStock market The collection of markets and exchanges where stocks, bonds and other securities are issued or traded.+ read full definition can sometimes be volatile—prices can move significantly over short periods of time, but what matters is whether your investments are right for you over the long termTerm The period of time that a contract covers. Also, the period of time that an investment pays a set rate of interest.+ read full definition. Learn more about how stocks work and if they fit you’re investing goals.

Read the full report

If you’re interested in how leading practitioners and regulators around the world are using behavioural insights to address issues in capital marketsCapital markets Where people buy and sell investments.+ read full definition and improve outcomes for investors and market participants, read the Investor Office Report – Behavioural Insights: Key Concepts, Applications and Regulatory Considerations (OSCOSC See Ontario Securities Commission.+ read full definition Staff Notice 11-778).

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