Investors Beware: “The Disposition Effect” – by David Adler

Original source: SimoleonSense.com .

David Adler wrote a book called Snap Judgment – I’ve tried multiple times to get him as an interviewee for the blog. Hopefully the 4th time will be the charm. In the meantime enjoy this essay, which accompanies the Nova Series: Mind Over Money (which I linked to in the prior post).

Introduction (Via David Adler)

Benjamin Graham once said, “An investor’s chief problem, even his worst enemy, is likely to be himself.” This is nowhere more true than when it comes to deciding to buy or sell a stock. We have an uncanny ability to buy stocks that are poor investments and sell stocks that are good investments. In essence, we buy high and sell low. In general, investors tend to shoot themselves in the foot—because they follow their instincts.

Once upon a time most economists and some investors thought people behaved rationally when it came to their money. Economic theory assumed investors, on average, would make good, even optimal decisions in terms of maximizing their wealth: Real money was at stake, so people would do the thing that earned them the most.

Psychologists who study how people make decisions were under no such illusions. They knew our decisions are driven by irrational impulses, gut instincts, and the way our brains process information, rather than the cold rationality embedded in economic models. Finally, researchers stopped arguing about theory and studied how investors actually make decisions. They found that investors behave the way psychologists predicted, not the way economists predicted. Behavioral economics was born.

Additional Excerpt (via David Adler)

He says, “Stocks with bad earnings announcements keep going down for awhile. Individual investors should just sell them. Waiting can only lose you money.”

For stocks with good news, waiting to sell makes sense. The disposition effect means everyone is selling, depressing the rise in price at first, but eventually it reaches fair value. Waiting eventually makes you money.

Click Here To Read: “The Disposition Effect” – by David Adler