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Strategies & Market Trends : Strictly Buy and Sell Set Ups -- Ignore unavailable to you. Want to Upgrade?

To: chowder who wrote (6749)	12/28/2005 8:46:46 AM
From: chowder	Read Replies (1) \| Respond to of 13449

A Remedy for the Sunk Cost Effect .................... Many long-term investors have trouble selling a losing position. It’s hard to admit that you have made a mistake. There is a natural, human tendency to deny you’ve made a mistake, and thus, it is easier to leave losses on paper. When a loss is left on paper, you can tell yourself that circumstances will turn around. You can hope against hope that you’ll end up profitable in the end. What usually happens, though, is that you hold the position and it loses even more money, and then the need to deny the loss and hold it is even stronger. Behavioral economists call this ailment the “sunk cost effect.” When you sink enough money in an investment, you want to believe that it was worth it. Sunk costs effects happen in everyday life as well as in business. Have you ever bought a piece of clothing on sale, taken it home, and regretted it later? You are likely to think, “No wonder it was on sale. It’s not quite right. Who would wear this?” Rather than just give the clothing to charity, however, we hold on to it. First, become aware of the sunk cost effect. Acknowledge the very human tendency to deny making a mistake and the need to stick with a losing trade, even if it hurts you in the long run. It helps to be aware of the phenomenon and admit that it is a powerful effect. Second, remind yourself of the costs and benefits of holding the losing trade. The benefit is usually that you don’t have to admit you are wrong and face how much money you have lost. This benefit is relatively short-lived, however. While you hold a losing trade, you usually end up losing even more money, you feel guilty and worried about losing (and waste a lot of psychological energy trying not to feel guilty or worried), and you miss out on other investment opportunities as you obsess over your losses. Focusing on the disadvantages of holding a losing trade will help you close it. Third, focus on the future. People fall prey to the sunk cost effect because they focus on the past, “I’ve already invested so much. I can’t sell it." It is easy to feel paralyzed when in the midst of a losing trade. The worst thing you can do, however, is try to ignore the situation. You are human. You make mistakes. Everyone does. When you are in a losing trade, don’t dig the hole deeper. Admit it, take action, and move on. The sooner you take action, the sooner you’ll make up the loss. Don’t get stuck; get moving, and take advantage of the endless investment opportunities available. Innerworth.com (These messages are linked to previous articles.)