Over on StockTwits this morning I am observing a bunch of comments from traders saying that they “sold this rally too soon.” This is a significant collective expression.
There are two important psychological processes occurring here which I will briefly outline for the sake of awareness raising among traders. These are loss aversion and regret.
1. Loss aversion: The two behavioral correlates to loss aversion are appropriately named the disposition effect as they are a universally human experience. These are the tendencies to hold losers too long and sell winners too soon.
The mechanics of these processes work like this. Within the domain of losses, market participants have an innate tendency to deny the figurative and literal realization of losses by avoiding them. They hold. Then, they proceed to cognitively rationalize the behavior with such statements as “well, maybe it will come back” etc. I have written about this here and here.
On the other side, within the domain of gains (when traders have winners) a mirror process occurs which relates to the desire to experience the pleasure of realizing gains. So they take gains too quickly.
I believe that this disposition effect within the domain of gains is in effect here. Whats more, it is accentuated by the environment. That is, stocks have been going down so furiously for so long that the experienced pleasure of realizing a long winner is intensified.
2. Regret – The second significant process occurring here is regret. That is, if someone takes a gain and then that winner continues to move such that the trader missed more gains by selling out, the trader regrets the missed excess profits.
The behavioral correlates to regret in the situation are variable. It will affect some who might spend valuable energy ruing while others will brush it off and move on.
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Structurally, I think the observation that this is occurring is a minor market positive data point as sellers into strength followed by continued strength will promote more chasers higher.
Further, I will not offer advice for anyone here. You can use the insights any way you would like. Awareness raising is only one small part of adaptively altering behavior and experience in general. Though, in the future on this blog I will have much more to say about initiating adaptive change processes…