Disposition effect.
In plain English
The disposition effect is the tendency to sell investments that have gone up while clinging to ones that have gone down. Shefrin and Statman named it in 1985, tying it to wanting the good feeling of a realized gain and dodging the bad feeling of a realized loss. The trouble is that it flips sound practice: it cashes out positions that are working and keeps ones that are failing, and it can also raise taxes, since selling winners can trigger gains while the losses that could offset them go unrealized.
01Why it matters
Selling winners and holding losers works against returns and can worsen the tax bill, so recognizing the disposition effect helps people judge a holding on its future prospects rather than on whether it is currently up or down from what they paid.
02The math, step by step
Two holdings: one up 30 percent, one down 30 percent. The pull is to sell the winner to bank the gain and hold the loser hoping it comes back. That locks in a taxable gain, keeps the weaker position, and is driven by feelings about the purchase price rather than by where each is likely headed.
03What this is NOT
It is not the same as a planned sale. Rebalancing or taking profit on a set rule is deliberate. The disposition effect is selling or holding because of the emotional sting of a loss or the comfort of a gain, not because of a plan.
04Receipts
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