That traders tend to cut their winners and let their losers run has been demonstrated by many studies. When they are on a winning trade, they become fearful that it will go bad, and they will lose the profits they have made. Conversely, when they are in a losing trade, they tend to hang in there waiting for it to come back into profit so that they don’t lose money. There’s even a comforting saying about it: ‘you haven’t lost until you’ve sold’.
Of course that is nonsense, but many people derive comfort from it and hold onto losing trades, sometimes for years. ‘I’ll sell as soon as it gets back to my buying price’ they say, blithely ignoring the fact that it has been going south for years there is little likelihood of this ever happening.
It’s called the ‘Disposition Effect’, and is related to prospect theory which says that people value gains and losses differently, which leads to inconsistent and sometimes irrational decisions-making.
Sunk Cost Fallacy
There is a related axiom, the sunk cost fallacy. This is the irrational commitment to a decision that has been made, based not solely on the purchase price of an asset, but the cumulative investment that the trader has made.
The time, the money, the emotions – influence their decision to hang in there, pursuing a losing course of action because of what they have already invested. You see this when traders hold onto a position they would never choose to get into now, but they hold because they are already there.
Why am I pondering on these right now? Because I have had two perfectly good examples of them in my own life this last week;
(Disposition effect). You may be wondering if it is time to get out of the market; after all we have made some lovely gains – should we sell up? It has occurred to me to advise everyone to ‘realise their gains’ and be happy with the profits we have made. I’ve even had the urge to do it myself as my accounts are all up very nicely and I’m a bit smug.
Am I going to? No, I will wait until we get an ITM signal, even though it means I won’t be getting out at the top of the market whenever that is.
We can all be brilliant traders in hindsight
Proof? I have just rolled all my nearer dated my positions out and up. Not what you do if you are going to sell up!
(Sunk costs). Last week was frustrating and infuriating. The website was down (FastComet maintenance – during business hours!), at the same time MailChimp decided that after more than 3 years of sending my emails that I might not own HeatherCullen.com after all. Then the server changes Mailchimp required didn’t work, but managed to knock out my email which was with another provider. Plus, my PC has had a problem with the hard drive that Dell can’t figure out.
Anyway, I won’t go into details, it was a perfect storm, and I was on the point of walking away from everything – books, blog, the lot – and going to trade quietly somewhere beautiful, rural France or a Greek island, perhaps. Then the ‘sunk cost’ effect kicked in – and I am still here!
To the markets
Well, stock market-wise, a rather lovely week! New all time highs in the S&P 500, the Nasdaq and the Dow!
No nasty days, just a slow steady rise. Nice.
Well, we have broken the 500 price barrier, and actually closed above it. Only for one day, however that is an encouraging sign. The other is the series of small candles, showing that most traders are generally in agreement that the price is right. The only worrying thing is that the volumes were below average all last week.
And in perspective: (I can’t yet draw in an uptrend on the weekly chart as only 2 points would be touching it.)
SPYG continues to climb, just like SPY. It has sailed through what I though might be a psychological barrier at 70, closing above it for 3 days now.
Unlike SPY it still has not taken out its previous high but is closing in on it. In perspective:
QQQ continues to rise.
And in perspective:
The VIX stays in low-volatility territory.
The week ahead
I have seen some more headlines using the word ‘euphoria’. Interesting. Are we in euphoria? I don’t think so, but I thought it would be fun to ask GPT 4. After the initial definition:
The euphoric phase is marked by a collective belief in the perpetual rise of the market, leading to risky behaviors and speculative investments.
I got a slap-down answer:
I can’t provide real-time analysis or confirm the current state of the stock market, including whether it is in a euphoric phase.
OK, not helpful. So I asked it to list the characteristics of the euphoric state and it did rather well – see below:
I don’t think that we are meeting most of these at the present time – but then infallibility definitely isn’t one of my attributes!
The futures, 8 hours before market open, are down marginally. I believe there is some inflation data coming out on Tuesday so things may be a bit quiet until then.
Well, fingers crossed for a good week – if it is anything like the last 2 weeks I will be very pleased.