ABSTRACT
People act (or fail to act) to avoid regret and seek pride, which causes investors to sell their winners too soon and hold their losers too long-the disposition effect. This behavior hurts investor wealth in two ways. First, investors pay more capital gains taxes because they sell winners. Second, investors earn a lower return because the winners they sell no longer continue to perform well, while the losers they still hold continue to perform poorly. The disposition effect can be seen in investor trades, market volume, and other markets like real estate and derivatives trading. A common rule of thumb to avoid letting the disposition effect impact you is to “cut your losses and let your profits run.”
Experiencing regret also causes investors to be less likely to repurchase the same loser stock later. However, investors do like to relive the good experience of selling a winner and watching a subsequent decline in the stock’s price.
