ForgeXWhat the research says
Why you sell winners and hold losers
10,000 accounts were examined. A position in profit was more than 50 percent more likely to be closed than one in loss, and it cost them 3.4 percent a year.
You know the feeling. The trade in profit is worth taking now, before it gives it back. The one in the red just needs a bit more room. It happens so consistently across so many people that it has a name and a measured price.
It has been counted
Terrance Odean examined "trading records for 10,000 accounts at a large discount brokerage house" and found investors "demonstrate a strong preference for realizing winners rather than losers" [1].
The size of it is the part worth sitting with. He found that "a stock that is up in value is more than 50 percent more likely to be sold from day to day than a stock that is down" [1].
It is not a good instinct
The obvious defence is that you are holding the loser because you expect it to come back. Odean checked that, by following what the sold winners and the held losers actually did afterwards.
"For winners that are sold, the average excess return over the following year is 3.4 percent more than it is for losers that are not sold" [1]. His conclusion is blunt: "Investors who sell winners and hold losers because they expect the losers to outperform the winners in the future are, on average, mistaken" [1].
What to do about it
The reason it happens is that closing a losing position is what turns it from a bad feeling into a fact. Leaving it open keeps the decision open too. That is a feeling, not an analysis, and the way to beat a feeling is to make the decision before you are in it.
Decide your exit before you enter, write it down, and then check afterwards whether you actually used it. That last part is the one people skip, and it is the only part that tells you whether this is happening to you.
It is also directly measurable on your own record. Compare your average win to your average loss. If your losses are much larger than your wins, this is probably why, and it is not because your losers were unlucky.
Sources
- Odean, T., "Are Investors Reluctant to Realize Their Losses?", The Journal of Finance, vol. 53, no. 5, 1998, pp. 1775 to 1798. https://onlinelibrary.wiley.com/doi/abs/10.1111/0022-1082.00072