Thread by @nilesh_agr

Do you hold on to your losers forever & sell your winners at small gains?
Do you average a losing position in hope to recover losses quickly?
Does “A loss is not a loss until realized” defines your portfolio strategy? Read On 1/n
#LossAversion #investing #markets #Behaviour

Welcome to the world of behavioural economics which studies how subconscious belief (or bias) influences financial decisions. In this case we are taking about a behavioural bias called “Loss Aversion” - simply put, a dislike towards losses. 2/n

You will ask, isn’t it natural to dislike losses?
True, it definitely is, but the problem arises when a ₹1,000 loss is much more painful than a ₹1,000 Gain. 3/n

According to Amos Tversky & Daniel Kahneman (Noble for behavioural economics), for those impacted by Loss Aversion, losing something you already have feels about twice as significant as gaining something of the same value. 4/n

So psychologically, the pain from a ₹1,000 loss is more than twice of happiness from a ₹1,000 gain.

Lets see how Loss Aversion impacts your decisions to understand it better: 5/n

1 Disposition Effect: It happens when you sell stocks in profit for small gains & hold on to losers. It is due to fear of giving up gains or them turning into losses. Psychologically, you believe that a loss is not a loss till realized, so hold on to it to avoid the pain. 6/n

2. Status Quo: You do not act on bad investments and hold on to them for a long period of time. Hope takes over rationality and you do nothing about bad choices. This is when a short term trade turns into a long term investment. 7/n

3. Increased Risk Taking behaviour: This is the reason for downward averaging of stocks below your purchase price. To avoid pain of a loss, you take more risk and add on to that losing stock, compounding your losses in most cases. 8/n

In a research by Tversky & Kahneman, participants were asked to choose between (1) a sure loss of 7,500 or (2) a roll of dice with 75% chance of losing 10,000 and 25% chance of winning 2,500. 9/n

Most chose to Gamble – thus, showing a risk taking behavior to avoid pain of a loss. Note, the probability outcome of both choices is the same – a loss of 7,500 [100% of 7,500 or 75% of 10,000]

How to overcome Loss Aversion? 10/n

1. Know about it: If you understand what Loss Aversion is, next step is to know when you are becoming a victim to it and try to not fall for its effects
11/n

2. Be disciplined and keep stop losses: A must for traders/investors to take out emotion out of the equation, as Loss Aversion is a fruit of emotional side of our behaviour

Share in comments if you have you experienced Loss Aversion and how it impacted you. 12/12 <end>