Loss aversion

Loss aversion is the tendency to feel the pain of a loss more intensely than the pleasure of an equivalent gain. Losing a thousand dollars feels considerably worse than gaining a thousand dollars feels good, even though the two amounts are identical in size, and that asymmetry shapes investor behavior in predictable ways.

In practice, loss aversion drives investors to hold onto losing positions far longer than the fundamentals justify, hoping to avoid locking in a loss, even when the money would be better redeployed elsewhere. It can also make investors overly cautious with new money, avoiding perfectly reasonable risks because the prospect of a loss looms larger in their mind than the roughly equal prospect of a comparable gain.

Loss aversion is closely related to the disposition effect, which is essentially loss aversion playing out as investors sell winners quickly while clinging to losers. Recognizing that a loss and a gain of the same size are, in strict financial terms, mirror images of each other, even though they do not feel that way emotionally, is a first step toward making decisions based on a position's actual prospects rather than on avoiding the discomfort of realizing a loss.