When profit is made, one wants to run; when losses occur, one stubbornly holds on. This may be the most genuine portrayal of many traders' inner feelings. This phenomenon is known as the "disposition effect" in behavioral finance, rooted deeply in human nature.
The disposition effect describes investors' tendency to sell profitable assets too early while holding onto losing positions for too long. The core reason lies in people's aversion to losses, which often far exceeds the pleasure derived from gains of the same magnitude. Research indicates that the psychological pain of losing $100 may require earning $150 or even more to offset. This asymmetric psychological response often invisibly dominates our trading decisions.
Another key factor is "cognitive dissonance." When we buy an asset based on our judgment but the market moves in the opposite direction, we experience strong internal conflict and discomfort. To alleviate this cognitive pain, we often choose to ignore unfavorable information or even double down, trying to prove that our original decision was correct. This leads to losing positions being continuously held or even increased, ultimately evolving into unbearable heavy losses.
The dangers of the disposition effect are evident: it makes us abandon trend-based profits too early while trapping us in ever-expanding losses. This not only erodes capital but also consumes a tremendous amount of time and energy, leaving us unable to attend to other higher-quality opportunities, falling into a vicious cycle of emotions and decision-making.
To overcome this psychological trap, the key lies in establishing a systematic response mechanism. First, clear and quantifiable rules must be set before trading, such as defining specific take-profit and stop-loss levels, and strictly adhering to them. Second, decision-making flexibility must be maintained; the market is always right. Once the trend proves our predictions wrong, we should decisively acknowledge the mistake and exit, rather than cling to the illusion that "the market will ultimately prove me right." True trading wisdom lies not only in seizing opportunities but also in having the courage to timely end mistakes.
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