People, it turns out, are not that averse to risk. For many reasons, they are not opposed to risk, but they are opposed to losing and the possibility of loss plays a very significant part in their decision.
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In any diversified portfolio, there will be both winners and losers, and the consideration that should determine which you should sell, if any, is certainly not the price at which you bought it originally.
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When deciding to sell, people have control over whether to give themselves pleasure or give themselves pain, and they tend to give themselves pleasure. In other words, they tend to sell winners and hang on to losers. It turns out to be a bad idea.
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It turns out that when people have to sell a stock from their portfolio, they are not rational between winners and losers. People tend to sell winners and hang on to their losers. The psychology of that is quite straightforward.
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One of the major differences between behavioral economics and standard economics is that, in standard economics, the individual agent is supposed to be driven or motivated by the utility of future wealth and discounted future wealth and present wealth. In behavioral economics, agents are supposed to be motivated by something else: gains and losses.
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Individual investors tend to churn their accounts, they tend to trade too much, and that they trade too much seems to be due to over-confidence. They believe they know something that they do not know and this is one essential characteristic of human beings, which makes them different from rational beings.
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Herding is not necessarily something one does as the result of analysis. It is what one does when one’s confidence is impaired.
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