Disposition Effect

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Definition

The tendency to sell winners rather than losers. One of a group of Behavioral Financial Biases that can cloud investors’ judgment. A telling study of the Disposition Effect took a look at the trading habits of 10,000 individual investors. The stocks that were sold at a gain outperformed the market by 2.4% over the subsequent 12 months. And the losers they held onto trailed the market by 1%. This bias, of course, flies in the face of the Recency Bias, where a stock that is performing well of late would be kept. But that’s the nature of irrational beliefs; taken together, they don’t necessarily form a rational whole. And investors may be afflicted with one and not the other.

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