I Take Profits Early and Cut Losses Late: Keeping Your Distance from the Disposition Effect [Investing x Psychology]
A day when profits felt light and losses felt heavy
One day, one of the stocks I held had gone up a little.
+8%.
It might still go up.
But I didn't want the unrealized gain on the screen to disappear, so I reached for the profit-taking button.
"Let's lock in the profit for now."
The moment I clicked it, I felt relieved.
The sense of security that the profit had become "mine."
......On the other hand, another stock was down -12%.
For some reason, I couldn't bring myself to sell this one.
"It might come back if I wait a little longer."
"If I sell here, it becomes a real loss."
Even though it's the same "settlement," locking in a profit is easy, while locking in a loss is heavy.
Today, I'm talking about this asymmetry of the heart—the disposition effect—.
The meaning changes when you "finalize" it
That day, I was in this state:
Unrealized gains make you want to protect them before they vanish
Unrealized losses make you feel secure because they are "not yet finalized"
Even though they are actually the same "settlement," the meanings feel completely different
When a profit is finalized, it becomes a "success."
When a loss is finalized, it becomes a "failure."
That is why I:
want to finalize successes early
want to put off failures
Even though my head knows I should "judge based on the expected value" of the stock, my heart tries to avoid "finalizing the result."
Before I knew it, I might have beentrading not for investment decisions, but to 'manage my emotions'.
The psychology behind it—The disposition effect
Thistendency to 'lock in profits early and hold onto losses for a long time'is called the
disposition effect.
Roughly speaking, it is thepsychology of wanting to secure profits while avoiding the realization of losses.
In the background, there is theinstinct of loss aversion.
People feel the'pain of loss'more strongly than the'joy of profit'for the same amount of money.
Therefore,
profits are 'protected before they disappear'
losses are 'gambled on the possibility of a recovery'
—this asymmetric behavior is prone to occur.
The problem is that this behavior tends to work in a direction that
makes profits smaller
and makes losses larger
.
The scary part of the disposition effect
1. Profits tend to be small, and losses tend to be large
Ideally, one should
continue holding stocks with a high potential to rise
and let go of stocks with a high potential to fall
.
However, when emotions move in the opposite direction,
selling rising stocks too early
holding falling stocks for too long
a reversal occurs.
② The criteria for judgment shifts from the "future" to the "past"
Instead of asking "what will happen to this company from now on,"
is it above the purchase price?
is it below the purchase price?
becomes the center of your decision-making.
You end up looking at "your own results" rather than the investment target itself.
③ "Waiting until it returns" becomes a rule
Even without a clear basis, a standard of "selling once it returns to the purchase price" is created.
But naturally, the market does not move based on your purchase price.
Countermeasures for the Disposition Effect
Since it is difficult to eliminate it completely, I keep the following three things in mind.
① Ask yourself, "If I didn't own it now, would I buy it?"
Set aside your purchase price and unrealized gains or losses for a moment, and think, "If I saw this stock for the first time at this price, would I buy it?".
If the answer is "no," then the reason to keep holding it becomes weak.
② Treat taking profits and cutting losses as the "same action"
Consider both as the act of reviewing your position based on new information.
Instead of "confirming success" or "confirming failure," I think of both as 'the task of re-deciding whether to keep holding' (updating your judgment).
3. Write down reasons for buying and selling based on "conditions," not "price"
Instead of "take profit at +10%,"
Sell if the growth scenario collapses
Sell if the premise changes due to earnings results
I structure it this way.
By making decisions based on premises rather than price, the influence of emotions is reduced.
Summary in one sentence: It is natural to be afraid of confirming.
Wanting to protect profits and not wanting to confirm losses are both natural human reactions.
The problem is that this natural tendency"makes you judge based on the past, not the future."
Recently, before pressing the settlement button, I try to ask myself once: Is this "emotional processing" or "updating my judgment"?
To everyone who has read this far
Have you ever experienced,
wanting to take profits early,
and thinking "if I wait a little longer" when it comes to losses?
Have you ever had such an experience?
If you'd like, I would be happy if you could share in the comments a situation where you felt the disposition effect. I am also still continuing to invest while dealing with this psychology (^-^)