Disposition effect
Why do traders tend to sell winners too early and hold losers too long, and how does that show up in a real week?
In plain words
The disposition effect is the habit of selling an asset that has risen in order to lock in a gain, while keeping an asset that has fallen in the hope it recovers. It comes from wanting the pleasure of a realised profit and avoiding the pain of a realised loss.
Why it matters
It distorts results even when the market direction is judged correctly. Gains are taken while they are small and losses are left open while they grow, so the average win becomes smaller than the average loss. It also matters because realised gains and losses have different tax and accounting consequences.
In a real week: ETH, week of 2 November 2020
In the week of 2 November 2020, ETH rose 14.53%, from 396.68 to 454.3, after 3 up weeks in the prior 4. A trader who bought at the weekly low of 370.23 on Tuesday might have sold after Wednesday's largest 1-hour move of 4.56%, or after Friday's best day of 9.4%, missing a close near 454.3 in the upper third of the week range. Holding through Saturday's worst day of -4.54% tested the same habit in reverse.
A common mistake
Assuming the effect only describes bad luck. It is a repeatable pattern in sell and hold decisions, measurable by comparing where gains and losses were actually realised.