Definition of disposition effect

The tendency of investors to hold losers too long and sell winners too soon.

Investors are willing to realise gains but are reluctant to realise losses. The effect is observed in experiments and over different investor types, time periods, asset classes, and countries. It is considered an irrational behavior, because selling and holding decisions should depend on the perceived future value of a security, but not the purchase price.

Some studies have documented that stocks investors sell due to the disposition effect (winners) outperform those they hold (losers); this means that investors would be better off by holding winners for longer and selling losers sooner.

The disposition effect is shown to be inconsistent with explanations based on information, rebalancing, or tax considerations. [1]

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