Trading Psychology | Endowment Bias – Do You Really “Own” a Stock?

People who exhibit endowment bias value an asset more when they own it, as compared to when they don’t. This is inconsistent with standard economic theory, which asserts that a person’s willingness to pay for a good should always equal the person’s willingness to accept disposition of the good.

 

Endowment Bias - Do You Really "Own" a Stock?

Endowment Bias – Do You Really “Own” a Stock?

 

In essence, this bias is a mental process in which a differential weight is placed on the value of an object. That value depends on whether one possesses the object and is faced with its loss or whether one does not possess the object and has the potential to gain it.

If one loses an object that is part of one’s endowment (ownership), then the magnitude of this loss is perceived to be greater than the magnitude of the corresponding gain if the object is newly added to one’s endowment.

For example, this bias influences traders to hold onto losing positions because they feel that they “own” the stock, and are reluctant to sell them and buy a better stock instead, although the potential gains are higher. This is often the result of decision paralysis, which places an irrational premium on the compensation price demanded in exchange for the disposal of the endowed asset.

What is the best solution for this?

One way to break free from flawed thinking is to ask yourself, “if you did not have any positions at the moment, would you still choose to buy the same stock which you are currently holding?” If you answered no, then you might want to reflect on why you are still holding onto it.

“A wise man should have money in his head, but not his heart.”

– Jonathan Swift

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About the author

Spencer is an avid globetrotter who made his first million at 28, spending just 15 minutes a day trading while travelling across 50+ countries. From there, he started building a diversified portfolio of stocks, REITs, ETFs, properties, and businesses.

 

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