Loss Aversion
Loss aversion is a cognitive bias where the psychological pain of losing is approximately twice as powerful as the pleasure of gaining an equivalent amount.
Exam Tip
Loss aversion: pain of loss = 2x pleasure of gain. Foundation of Prospect Theory (Kahneman & Tversky). Causes holding losers, selling winners early.
What is Loss Aversion?
From Kahneman & Tversky's 1979 Prospect Theory. Pain of losing $100 ≈ 2x pleasure of gaining $100.
How It Affects Investing
| Behavior | Consequence |
|---|---|
| Holding Losers | Hope they'll recover |
| Selling Winners Early | Lock in "sure" profits |
| Panic Selling | Lock in losses at worst time |
Strategies to Overcome
- Pre-commitment plans (stop-losses)
- Focus on portfolio returns, not individual positions
- Systematic rebalancing
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