Market Psychology: It's Painful to Let Go of a Sagging Stock

A new study from the SPAN (Symbiotic Project on Affective Neuroscience) lab at Stanford University describes the endowment effect. Hypothesized by Dr. Richard Thaler, the endowment effect essentially states that people place higher value on objects they own than objects they do not. In a classic experiment for example, people demanded higher price for a coffee mug that had been given to them, but put a lower price on one they did not yet own.

Previous studies have shown that the endowment effect has deep evolutionary roots. In 2006 for example, Keith Chen at Yale Universty gave peanut butter and juice bars as treats to chimps. When presented with a choice, 60 of the chimps preferred peanut better to juice. However, when the chimps were “endowed” with peanut butter, 80% of them chose to keep the peanut better instead of exchanging it for juice. It is as if the peanut butter immediately became more valuable than the juice bar when it was owned.

One explanation for this phenomenon is that many living beings are hardwired for “scarcity,” that is, we don’t want to let go of something we already have. According to the SPAN research, the anterior insula often activates when someone is afraid of losing something, when they are in pain, and when they are experiencing disgust. Letting go of something that we own actually triggers the pain emotion.

The endowment effect is applicable in all aspects of our lives including investing in the markets. Research by Andreas Fuche and David Johnstone in the Journal of Behavioral Finance showed that sellers in the stock market value their own shares higher than buyers independent of current market price, by consistently placing sell orders on average higher than any bid orders.

This is yet another reason why its so hard to let go of a sagging stock, especially one that you had hand-picked, or one that has a promising story or one that was previously a high-performer. According to neuroscience it’s painful for you to let go!

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Comments

[mariposa:]

Tis true. Now what? Will it turn around? Wishful thinking, or strong likelihood? That is the art of investing.

2008 Jun 23 10:19 AM

[Clavis:]

Affirms my thinking, that is why I always put a sale price on an object before I buy it, might miss some extra profits but a lot better for the stress levels!

2008 Jun 23 11:53 AM