Investor Psychology: Falling in Love with Our Stocks
All of us have had difficulty selling stocks whether we’ve made a good profit or taken a sizable loss. Why do we doubt ourselves when we make the decision to sell?
Well, renowned Harvard psychologist Daniel Gilbert in Stumbling on Happiness offers an answer:
“Because experiences are inherently ambiguous, finding a ‘positive view’ of an experience is…simple…and research shows that most people do this well and often. Consumers evaluate kitchen appliances more positively after they buy them, job seekers evaluate jobs more positively after they accept them, and high school students evaluate colleges more positively after they get into them. Racetrack gamblers evaluate their horses more positively when they are leaving the betting window than when they are approaching it, and voters evaluate their candidates more positively when they are exiting the voting booth than when they are entering it. A toaster, a firm, a university, a horse, and a senator are all just fine and dandy, but when they become our toaster, firm, university, horse, and senator they are instantly finer and dandier. Studies such as these suggest that people are quite adept at finding a positive way to view things once those things become their own.”
I’m willing to bet good money that investors evaluate their stocks more positively after they have purchased shares than before they made the purchase. This psychological effect explains why we can’t let go and take profit on our shares of ABC after it has had a massive run-up because we think that it must go up more. This mindset also explains why we can’t let go and limit our losses on our shares of XYZ after it has taken a big hit because we think it must bounce back. (This psychological trick also explains why many Texas Hold ‘Em poker players can never fold pocket aces or kings even when they know that they’re beat.)
So how can we combat our natural instincts in order to make better decisions in the stock market? A good method that many professionals use is to remove yourself from your “ownership” position. Pretend for a moment that you did not own shares of the company and ask yourself if you would purchase the stock then. If the answer is yes, then you might consider holding onto it. If the answer is no, then by all means sell your shares.