Disposition Effect
The behavioral tendency to sell winning investments too early and hold losing ones too long.
What is Disposition Effect?
The disposition effect, documented by Shefrin and Statman (1985), describes investors' systematic tendency to sell stocks that have risen in price ('winners') too quickly while holding stocks that have fallen in price ('losers') far too long. This pattern is driven by loss aversion — investors realize gains to secure positive emotions and avoid realizing losses to sidestep negative ones. The effect is economically harmful: winners often continue rising (momentum) while losers often continue falling. It also creates adverse tax consequences, as realizing gains triggers capital gains taxes while holding losers foregoes loss harvesting.
Example
An investor holds two stocks: Apple (up 30%) and a retail company (down 40%). The investor sells the Apple position to 'lock in' gains while continuing to hold the losing retail position, expecting a recovery. Empirical research confirms this pattern is pervasive: Odean (1998) found that the stocks investors sold outperformed the stocks they held by about 3.4 percentage points over the next year.
Source: Shefrin & Statman — The Disposition to Sell Winners Too Early (1985)