Do you sell stocks that show profits and hold stocks that are losses?
Have you held onto losing stocks for a long time? Quietly hoping for the stock price to rebound to your purchase price?
This is just a human cognitive bias. It is known as loss aversion, which means that you would get more depressed by losses than receiving more joy from winning the same amount. This is also one of the reasons why people are interested in capital guaranteed investments. They fear loss and are willing to take much less profits, some times lower than the inflation rate (e.g. fixed deposit). They become irrational, even though their money is eroding as the returns are not able to match inflation, but they still feel good and safe doing it.
This is probably one of the reasons why we have boom and bust in the stock market. During a bull run, the fear of loss reduces and more people will be willing to buy stocks. When the stock market crashes, money pulls out of the market faster than the time it takes for the bull to run (ie. if a bull run takes 3 years, a crash can just take 1 year or less). This asymmetric observation reinforces the loss aversion of humans. We really fear loss more than we appreciate gain. After the lesson, people become fearful and they start to buy safer instruments like bonds and money market funds.
[Free Ebook] How should you invest your first $20,000?
We asked 14 Singapore finance bloggers to share what they would do if they could go back in time and invest their first $20,000. They can no longer rewind time, but you can learn from their experience and hopefully start with a better footing.
If most people lose money in the market, don’t you think it is unwise to do what the majority do?
Below is a nice short video about loss aversion: