Selling a stock that has fallen means admitting the purchase was a mistake, and selling one that has risen means banking a win. Those two feel very different and should not, since what matters is what each stock does next. The names the resulting bias. So the trading records of 10,000 accounts at a large discount brokerage were examined. Which way did it run?
A strong preference for selling winners. These investors showed a marked tendency to realize gains rather than losses, holding losing investments too long and selling winning ones too soon. The behavior did not appear to be motivated by a desire to , or to avoid the higher trading costs of low-priced stocks, and it was not justified by how the portfolios subsequently performed. For taxable investments it is suboptimal.
A stock that has risen and a stock that has fallen pose the same question: which is more likely to do well from here. Psychologically they pose different questions, because selling the loser makes a mistake final while selling the winner books a success. The disposition effect is the name for the resulting asymmetry.
Testing it needs behavior rather than survey answers, so this study analyzed trading records for 10,000 accounts at a large discount brokerage house. The records show what people did with their own money, which is the only evidence that settles a question about motivation this uncomfortable.
These investors showed a strong preference for winners rather than losers. Then come the alternative explanations, each of which would produce the same pattern innocently. Their behavior did not appear to be motivated by a desire to rebalance portfolios, or to avoid the higher trading costs of low priced stocks. Nor was it justified by how the portfolios went on to perform, which rules out the possibility that they were simply right about which stocks to keep.
For taxable investments the preference is suboptimal and leads to lower , since realizing gains invites tax that realizing losses could have offset. Tax-motivated selling is most evident in December, which shows investors do respond to the incentive when it is salient. Read the evidence for what it is: archival records establishing a pattern and its cost, with the motive inferred rather than observed.
wat. Given a winner and a loser to choose between, these investors sold the winner, and their later returns did not reward them for it.
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The alternatives are what make it convincing. Rebalancing, trading costs and good judgment about future returns were each checked and none accounted for the pattern, which leaves the discomfort of admitting a loss.
How do we know?
Odean analyzed trading records for 10,000 accounts at a large discount brokerage house, testing the disposition effect against alternative explanations including portfolio rebalancing, trading costs and subsequent performance.
What is still unknown
Archival trading records from one brokerage in the 1990s, so the motives are inferred from behavior rather than reported. It shows the pattern and its cost without establishing what any individual was thinking.
Learn something?
Where to next
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