One of the most quoted trading commandments on Wall Street says that you should: „Let your profits run and cut your losses short“. The trading wisdom of letting profitable trades run as long as possible and limiting losses is one of the oldest and most quoted trading “rules”. As a trader you can of course open and close a position whenever you want – but it is not always easy to do the right thing for the human brain. DISPOSITION EFFECT The reason is the so called disposition effect. This is an anomaly of the human psyche which is analyzed in the field of behavioral finance. The human brain tends to the opposite – letting losses run and cutting profits short.
Very informative, thank you. It is very true that most people are more likely to let losses run (believing that it has to change soon) and cut profits short (do not want to risk it turning around). Never knew that there are actually a name for this type of behaviour.
Great article. Thank you! As a poker player, I understand this concept all too well. If I'm running really well at the table, I'm likely to stand up and leave a lot sooner than I would, even though I was playing really well. And when I'm not running well and about half stack, I actually get more risky with my bets. Just very good information to keep in mind.
It's an interesting phenomenon in that when people are wrong they will do anything to prove they are actually right and yet when they make a correct decision they will bail out as soon as possible. It all goes to show that to be a successful trader, you have to take any emotions out of the game.
I don't think its just those point previously mentioned. If it looks like there is a profit being made, people are quick to collect, for fear of the market plummeting.
I think that's exactly what goes on. People subconsciously want to be proven right so they will stubbornly keep their losing stocks in the hopes that they will one day recover. And then as for profits, they bail out after a while for fear of a drop in value, and as long as you can say you sold at a profit, that's good enough
Great tip! I think sometimes we are just as scared as success as failure. We know who we are already without great success. It may lead us to cut the high profits short a bit.
