Definition
Loss aversion is a cognitive bias where the psychological pain of losing is roughly twice as powerful as the pleasure of gaining an equivalent amount. This leads investors to hold losing positions too long (hoping to break even) while selling winners too quickly (locking in gains). Loss aversion can cause risk-averse behavior when facing gains but risk-seeking behavior when facing losses. Understanding this bias helps investors make more rational decisions and implement systematic rules to counteract it.
Example
An investor holds a stock down 30%, hoping it recovers to their purchase price, while quickly selling another stock up 15% to 'lock in gains.' This behavior often leads to a portfolio of losers and missed winners.
FAQ
What is Loss Aversion?
The tendency to prefer avoiding losses over acquiring equivalent gains.
Why is Loss Aversion important?
Loss Aversion helps investors evaluate behavioral finance and make more informed decisions.