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Author Topic: Why We Can't Let Go of Our Losers  (Read 1961 times)
EuSouBitcoin
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October 16, 2011, 03:41:29 PM
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http://online.wsj.com/article/SB10001424052970204774604576631302847124750.html?mod=WSJ_hpp_MIDDLE_Video_Top

Taking a loss is hard to take. But avoiding a loss can be much worse.

U.S. stocks have lost some $4 trillion since their peak in October 2007, but investors aren't fleeing the market en masse. So far this year, according to investment-research firm Morningstar, investors have taken $14 billion more out of U.S. stock mutual funds and exchange-traded funds than they have added. That is less than 0.4% of the total assets of U.S. stock funds.

In other words, while some investors have taken their losses, most are grimly sitting on them.

That could be a mistake. Research published in 1998 by behavioral-finance professor Terrance Odean of the University of California, Berkeley, showed that individual investors are 50% more likely to sell a winning stock than a loser—even though, on average, the stocks these investors sell go on to outperform while those they hold onto underperform.

Why the reluctance to bail? Selling an underwater asset, says Mr. Odean, "isn't primarily about economic loss, it's about emotional loss." Once you sell below your purchase price, he believes, you can no longer tell yourself, "I still made a good choice, and it'll come back."

Individual investors aren't the only ones who can't make peace with their losses, according to numerous academic studies. Mutual-fund managers who cling to losing stocks underperform, by roughly four percentage points annually, the managers who cut their losses.

On average, professional futures traders and stock traders hurt their returns by clinging to their losers. Real-estate investment trusts hang onto properties that are losing money longer than they keep those that are in the black.

Unpublished research presented at the annual meeting of the Society for Neuroeconomics earlier this month sheds new light on this old problem. Neuroeconomics is an emerging field that combines the techniques of neuroscience with theories from psychology and economics to study financial behavior.

In one study, led by Gregory Berns of Emory University, people lay inside a brain scanner while deciding to hold or sell an investment; the price of the asset changed randomly up or down. The researchers focused on the ventral striatum, a region of the brain that has been shown to respond to rewards, particularly when they are unexpected.

When an asset was underwater and its price rose, activity in the ventral striatum of the typical person in the experiment was "blunted," or insignificant, rather than robust. "Many of the participants told us they had hope for a rise," says Andrew Brooks, a co-author of the study. Perhaps because these people got what they expected, an uptick in price "wasn't surprising," Mr. Brooks says, and therefore didn't excite this part of the brain's reward center.

That suggests that many investors who are losing money may automatically assume—rightly or wrongly—that their position is bound to recover.

Other research at the meeting pointed to a second flaw in how investors might think about losses. A study led by Camelia Kuhnen of Northwestern University found that people are much worse at estimating whether a bad investment will produce mild or severe losses than they are at predicting whether a winning investment will generate small or large gains. "Learning [about probabilities] is particularly faulty," Prof. Kuhnen says, "when people are in a bad environment with losses left and right and they have their own money at stake."

There are several steps that can help you dump your losers.

First, get a second opinion, from a financial adviser or an investor you respect, on your money-losing positions. Ask not whether you should sell the investments, but rather if they are worth buying at today's price. If the answer is no, consider selling.

Measure how long you hold your losers and your winners. If you hang onto your money-losing positions much longer than your winners, then put yourself on a regular schedule of looking for losses to harvest. (You don't have to wait until December.)

Taking a loss is easier when you think of it as a swap—in which you replace a loser with a new investment in a similar (but not identical) asset—rather than a sale. That makes taking action easier, since you aren't forced to admit that your original judgment was a complete failure.

Finally, realize that a loser can change from a liability to an asset when you close it out at a loss, since you can use losses to offset up to $3,000 of ordinary income on your tax return.

"Think about the term 'harvesting your losses,'" suggests Meir Statman, a finance professor at Santa Clara University. "That should put you in mind of strolling in an orchard picking ripe peaches rather than rotten losses." Just be sure to check with your accountant to make sure the loss is worth taking.
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October 16, 2011, 04:12:42 PM
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does anybody else enjoy watching the panic selling?

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October 16, 2011, 06:13:26 PM
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does anybody else enjoy watching the panic selling?

I enjoy it, but lets rephrase this. It is not panic selling, especially at this point. It is people being rational and finally realizing that bitcoins are not worth much money. They want to get out before it falls even further, which it will. It is not panic selling at this point but smart selling.


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October 16, 2011, 06:18:47 PM
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does anybody else enjoy watching the panic selling?

I enjoy it, but lets rephrase this. It is not panic selling, especially at this point. It is people being rational and finally realizing that bitcoins are not worth much money. They want to get out before it falls even further, which it will. It is not panic selling at this point but smart selling.



It's people rightly panicking in order to quickly get out before, as you say, it falls even further.
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October 16, 2011, 08:29:50 PM
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This is not capitulation, this is just more slow pain.  Capitulation would be deepbit going to around 200Mhash and the price diving to around a buck.  Nothing to see here, just more money being squeezed out of the dumber bulls.
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October 16, 2011, 08:50:11 PM
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Interesting read. I know that a lot of successful investors are well aware of how to use market psychology to gain an edge over smart people who can't quite look at themselves without bias.   

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October 16, 2011, 10:31:28 PM
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I wouldn't say I'm enjoying the falling price, but it is fascinating to watch.  All the excuses that seemed so silly back when people were justifying a $10+ price seem even sillier now.

Could bitcoin ever go back to $10?  Sure.  If I miss the boat I'll be quite annoyed.  But the chorus of 'get back in the market now, it's about to boom!' hasn't stopped all the way from $32 to $3.50.  I'm sure someone will soon post another pretty graph to show bitcoin is still in a massive bull market.

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October 17, 2011, 12:45:53 AM
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I'm sure someone will soon post another pretty graph to show bitcoin is still in a massive bull market.
All these drops are just noise. Look at the yearly moving average!
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October 17, 2011, 01:09:26 AM
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I'm sure someone will soon post another pretty graph to show bitcoin is still in a massive bull market.
All these drops are just noise. Look at the yearly moving average!

When does noise become a trend? After 6 months?  A year?  Three or five years?

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October 17, 2011, 02:42:05 AM
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I'm sure someone will soon post another pretty graph to show bitcoin is still in a massive bull market.
All these drops are just noise. Look at the yearly moving average!


Irrelelvant.  75% of the mining power and by proxy the bitcoin community joined between June and August.   For them the "long term" trend is academic, for them the trend looks completely different than for the 25% who are the top of the pyramid.

Yes, those 25% are not panicking.  But OTOH, they're not the ones with much skin in the game.
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October 17, 2011, 09:31:49 PM
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No hats to any of you who didn't feel any sarcasm...
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October 18, 2011, 01:42:54 AM
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No hats to any of you who didn't feel any sarcasm...
I was embarrassed for them.

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October 18, 2011, 02:49:22 AM
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No hats to any of you who didn't feel any sarcasm...
I thought it was a lovely graph.

What is funny are those that want to link irrational human behaviour to empirical analysis.

Another thought for the OP, I have some stocks/equities, and they are priced well below my buy-in price, but it means my dividend yield looks better on a percentage basis.  ie, a $1000 dividend on x shares when the price is $1.00 or $0.80 is still $1000.
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