What is loss aversion in investing?

Loss aversion is the tendency for a loss to feel worse than a gain of the same size feels good. In investing it shows up as reluctance to sell a position at a loss, even when the reason for owning it has gone.

What is the disposition effect?

The disposition effect is the habit of selling investments that have risen too soon and holding investments that have fallen too long. It was named by Shefrin and Statman in 1985 and has been measured in real brokerage accounts.

Loss aversion and the disposition effect

Why losses hurt more than gains feel good, what prospect theory says, and why investors and traders tend to sell winners and hold on to losers.

Part of the Psychology and Discipline track on Agenticks. About 10 minutes, written for a intermediate reader.

Read first: Cognitive biases in investing and trading.

Last reviewed 2026-11-08.

Key takeaways

Loss aversion means a loss feels worse than an equal gain feels good; experiments put the weight on losses at a little over twice that on gains.
Prospect theory says people judge outcomes from a reference point, such as the price they paid, and take more risk to avoid a sure loss.
The disposition effect is selling winners too soon and holding losers too long; in 10,000 brokerage accounts, winners sold went on to beat the losers kept.
For traders, cutting winners short and letting losers run can turn a high win rate into a losing strategy.
Deciding the exit before entering, and asking whether you would buy the position today, takes the reference point out of the decision.

Losing $100 does not feel like the mirror image of finding $100. It feels worse. That gap has a name, loss aversion, and it sits at the center of prospect theory, the description of risky choice published by Daniel Kahneman and Amos Tversky in 1979. Prospect theory makes two claims that matter for anyone with money in the market. First, people judge outcomes as gains or losses measured from a reference point, usually where they started or what they paid, rather than as total wealth. Second, the pain curve for losses is steeper than the pleasure curve for gains. In later experiments, the typical person needed a possible gain of a little over twice the possible loss before a 50/50 bet felt acceptable; the authors' median estimate of the weight on losses was 2.25.

Worked example: a fair bet that feels unfair

A coin flip loses $100 on tails and wins $150 on heads. Below, the felt value weights the loss by 2.25, the median estimate from Tversky and Kahneman (1992). Illustrative numbers.

Expected value (0.5 x $150 - 0.5 x $100)	+$25 per flip
Loss as it feels ($100 x 2.25)	-$225
Felt value of the bet (0.5 x $150 - 0.5 x $225)	-$37.50
Win needed to feel neutral (the gain that balances a felt loss of $225)	$225
What happens	A bet worth +$25 on average gets turned down

The 2.25 is an average from experiments, not a constant of nature. Individuals vary, and context matters.

Prospect theory has a second twist. Below the reference point, the curve flattens out, so people often prefer a gamble to a sure loss. Offered a certain loss of $500 or a coin flip between losing $1,000 and losing nothing, many choose the flip. That is the logic of holding a falling stock in the hope it comes back, or adding to a losing trade to "get it back". Both swap a loss you can see for a gamble on not having to admit it. You can check the arithmetic behind bets like these in our lesson on edge, expectancy and variance: what matters is the average outcome over many tries, not how one outcome feels.

The market does not know your reference point

The price you paid decides whether a position feels like a win or a loss. It has no effect on what the position does next. Loss aversion makes that number feel important, which is exactly why it needs to be taken out of the decision.

The disposition effect In 1985 Hersh Shefrin and Meir Statman gave a name to what loss aversion does to selling: the disposition effect, the tendency to sell winners too early and ride losers too long. Terrance Odean then tested it on the trading records of 10,000 accounts at a large discount broker from 1987 to 1993. The method was simple. On each day an investor sold something, Odean counted every position they held as a gain or a loss, and recorded which ones they actually sold. Across the year, investors realized about 14.8% of their available gains but only 9.8% of their available losses. Only in December, when realizing a loss can lower a tax bill, did the pattern flip. The selling was not rewarded. Over the following year, the winners investors sold beat the losers they kept by an average of 3.4 percentage points, measured against the market. Odean also noted that, in a taxable account, selling winners and holding losers usually brings tax forward. Tax rules depend on where you live and your situation, so that point is about the pattern, not a rule to apply.

The trader's version Active traders show the same pattern on a shorter clock. A small open profit gets taken quickly because it feels good to lock in. A small open loss gets more room: the stop is moved further away, or removed, because closing would make the loss real. The arithmetic is unforgiving. Say a trader wins 60% of the time, but cuts winners at an average of +$100 and lets losers run to an average of -$200. Per trade, that is 0.60 x $100 = $60 won and 0.40 x $200 = $80 lost, an average of -$20 per trade before costs. A win rate that sounds healthy hides a strategy that loses money. This is also one reason the win rate alone tells you little. Now flip the habit. Suppose the same trader lets winners reach +$200 and cuts losers at -$100, and the win rate drops to 40% because some trades that used to scrape a small profit now get stopped out first. Per trade: 0.40 x $200 = $80 won, 0.60 x $100 = $60 lost, an average of +$20. Fewer wins, better result. The illustrative numbers are chosen to make the point, but the shape is general: the size of wins and losses matters as much as how often you win. The same instinct drives unplanned averaging down, where an investor or trader buys more of a falling position mainly to lower the average price. Adding to a position can be a deliberate part of a written plan. Adding because the loss is uncomfortable to accept is loss aversion making the position bigger.

winners losers reference

What helps Decide the exit before the entry. For a trader, that means the stop and the target are set when the trade is placed, ideally with a stop or bracket order so the exit does not depend on willpower in the moment. Ask the fresh-money question. If you had cash instead of this position, would you buy it today at this price? If not, the main reason to keep it may be the reference point. Judge a position against its written reason. An investor who writes down why they bought, and what would prove that reason wrong, can review a holding against that note instead of against the purchase price. Review sells, not just buys. A journal that records what you sold, and what happened afterwards, shows whether you have this habit. The next two lessons cover overtrading and how to keep that kind of journal.

You own two stocks. One is up 20%, the other is down 20%, and you need cash. You notice you want to sell the winner. What question best checks for the disposition effect? Which of these would I buy today, at today's price, if I held cash instead? This looks only forward. The gain or loss since purchase is left out, because it says nothing about what each stock does next.

You understand loss aversion

You can now explain why losses weigh more than gains, how that becomes the disposition effect, and how deciding exits in advance takes the purchase price out of the choice.

Check your understanding

A 50/50 bet loses $100 or wins $150. Its expected value is +$25, yet many people turn it down. What best explains that?: Loss aversion: the possible $100 loss feels heavier than the possible $150 gain. With losses weighted about twice as heavily as gains, a $100 loss can feel bigger than a $150 gain, so a bet with a positive expected value feels like a bad one.
In Odean's 1998 study of 10,000 brokerage accounts, what did investors do?: They realized gains at a noticeably higher rate than losses, outside of December. About 14.8% of available gains were realized against 9.8% of available losses over the whole year. In December, when selling losses can reduce tax, the pattern reversed.
A trader wins 60% of the time but averages +$100 on winners and -$200 on losers. What is the average result per trade before costs?: -$20. 0.60 x $100 = $60 won, 0.40 x $200 = $80 lost, so the average trade loses $20.
Which habit takes the purchase price out of a selling decision most directly?: Writing the exit rule before entering and asking whether you would buy the position today. Both questions look forward at the investment rather than back at what you paid, which is the reference point loss aversion clings to.

Common questions

What is loss aversion in investing?: Loss aversion is the tendency for a loss to feel worse than a gain of the same size feels good. In investing it shows up as reluctance to sell a position at a loss, even when the reason for owning it has gone.
What is the disposition effect?: The disposition effect is the habit of selling investments that have risen too soon and holding investments that have fallen too long. It was named by Shefrin and Statman in 1985 and has been measured in real brokerage accounts.

Terms defined in this lesson

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Written and reviewed by the Agenticks Learn editorial team. How we write and check lessons.

Agenticks Learn is general education. It is not financial, investment, tax or legal advice, it does not take your situation into account, and nothing on it is a recommendation to buy, sell or hold any security or to open any account. Examples use illustrative numbers. Investing involves risk, including losing money you put in, and past performance does not predict future results. Tax rules and limits change; the official sources linked in each lesson are the final word.