Do investors really sell winners and hold losers, thereby helping the market beat them? In other words, are they reluctant to admit mistakes? In their November 2006 paper entitled “Is the Aggregate Investor Reluctant to Realize Losses? Evidence from Taiwan”, Brad Barber, Yi-Tsung Lee, Yu-Jane Liu and Terrance Odean investigate whether the average investor exhibits the disposition effect, the tendency to sell winning investments at a faster rate than losing investments. Using data for all trades on the Taiwan Stock Exchange during 1995-1999 (over one billion trades by nearly four million traders), they conclude that:
- Investors in the Taiwanese stock market are about twice more likely to sell a winning stock position than a losing stock position, and 84% of them sell winners at a faster rate than losers.
- Individuals, corporations, and dealers are reluctant to realize losses, while mutual funds and foreigners are not.
- Short sellers are also reluctant to realize losses.
- Men and women exhibit about the same level of reluctance to realize losses.
- The tendency to sell winners (losers) decreases (increases) after stocks go up, and increases (decreases) after stocks go down. However, because the increase in winning positions dominates the decrease in the tendency to sell winners, the overall willingness to sell increases following market advances.
- The disposition effect does not produce momentum in Taiwanese stock returns, perhaps because the effect of investors chasing performance offsets any effect of their preference to sell winners.
The following table, excerpted from the paper, shows Proportion of Gains Realized (PGR) and Proportion of Losses Realized (PLR) by investor type for the entire five-year sample, and calculates whether selling winners dominates selling losers based on both value of trades and number of trades. It shows that individual investors and dealers are most prone to sell winners rather than losers. It also shows that foreigners are more likely to sell losers than winners.
In summary, data from Taiwan strongly supports the conjecture that investors avoid taking losses so that they do not have to admit mistakes.
Investors may want to think about whether they are holdling losers on hope.
