The disposition effect (Shefrin & Statman, 1985) — selling winners too early and holding losers too long.
• Winner: feels good → sell to "lock in" pleasure → miss further gains
• Loser: feels painful → hold to avoid realizing pain → loss deepens
Result: The exact opposite of the rational strategy — let winners run, cut losers short.
It's also tax-inefficient: you pay capital gains tax on winners early but can't deduct unrealized losses.
Odean’s measure: on each day something was sold, look at every position held. Here 4 of 8 positions in profit were sold — a proportion of gains realized of 0.50. Only 1 of 9 in loss was sold: 0.11. Gains were realized 4.5 times as readily as losses. In 10,000 real brokerage accounts Odean (1998) found 0.148 against 0.098.
- Taxes push the other way: in most countries a realized loss lowers your tax, which makes holding losers more costly still.
- Some selling of winners is rebalancing, which is a good habit; the test is whether the sell would happen with the gain removed.
- Ben-David & Hirshleifer (2012) found people sell after large moves either way; the pattern may come from beliefs about the stock more than from the pain of a realized loss.
book = pd.DataFrame({ # every position held on the days something was sold
'gain': [1, 1, 1, 0, 0, 0, 0, 1, 1, 0, 0, 0, 1, 1, 1, 0, 0],
'sold': [1, 0, 1, 0, 0, 0, 0, 1, 0, 0, 1, 0, 1, 0, 0, 0, 0]})
g, s = book.gain == 1, book.sold == 1
PGR = (g & s).sum() / g.sum() # proportion of gains realized (Odean 1998)
PLR = (~g & s).sum() / (~g).sum() # proportion of losses realizedAssumes import numpy as np and import pandas as pd. Each snippet carries its own example numbers; the comments say which are made up.
- H. Shefrin & M. Statman, “The Disposition to Sell Winners Too Early and Ride Losers Too Long: Theory and Evidence”, Journal of Finance 40(3), 1985
- T. Odean, “Are Investors Reluctant to Realize Their Losses?”, Journal of Finance 53(5), 1998
- I. Ben-David & D. Hirshleifer, “Are Investors Really Reluctant to Realize Their Losses? Trading Responses to Past Returns and the Disposition Effect”, Review of Financial Studies 25(8), 2012
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1. What is the disposition effect?
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B. Shefrin & Statman (1985) named it; realising a loss is painful, realising a gain feels good.
2. In Odean’s (1998) study of brokerage accounts, how did the winners investors sold compare with the losers they kept?
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C. The difference was about 3.4 percentage points over the next year — the habit cost money, not just taxes.
3. Why is the disposition effect costly for taxes too?
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B. Tax rules usually reward the opposite: realise losses, defer gains.