Deepthinking second post. I’ve dealt with hand-solding that I think is essential to becoming a successful investor.

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I should have sold it then…Also, the difference between an ant that loses and a trader that always earns
[Ed. note] The era of artificial intelligence, represented by ChatGPT, is coming. Now, the depth of thinking is more important than knowing a lot. Let’s think about deep thinking in the AI era.

An investor who bought a large stock of a secondary battery when the secondary battery stock was at its peak last year and its stock price was cut by one-third. Now that I think about it, I regret that I should have pressed the sell button when the stock price, which had been soaring, gradually changed its direction to a downward trend. But I couldn’t afford it at that time.

One of the main reasons individual investors fail in stock investment is that they cannot sell when the stock price falls. Usually, stocks that make profits sell too quickly to enjoy greater profits, and stocks that lose do not sell off, resulting in snowballing losses.

The reason why it is hard to sell hands is that we feel twice as much pain from loss as we do from joy from profit. Traders who succeeded in “Market Wizards” published by bestselling author and hedge fund expert Jack Schweger were almost one-on-one in their emotional changes caused by losses and profits.

1. Investors hedging their profits and risking their losses

Daniel Kahneman, a former Princeton University professor who died this year, won the 2002 Nobel Prize in Economics through Professor Amos Tversky and his 1979 prospect theory.

To explain the prospect theory, let’s look at the experiment below on prize money and fines.

①You get $450 with 100% probability. (Expected value $450)
②You get $1000 with 50% probability, but you don’t get a penny with 50% probability. (Expected value $500)

When asked to choose between ① and ② for prize money, many people choose ① with certainty, which gives them a $450 prize. Although the expectation of ② is higher at $500, people tend to be risk-averse and choose a stable $450 prize.

③Fines $500 at 100% chance (expectation value – $500)
④Fines $1100 with a 50% chance, but is exempted with a 50% chance. (Expected value – $550)

However, when it comes to choosing a loss, on the contrary, people pursue risk (risk-seeing). When you are asked to choose between ③ and ④ when you pay a fine, many people choose ④ rather than ③ to pay 500 dollars. Rather than a 100% sure loss, you choose an alternative that you won’t pay a penny even if the expected loss is large.

It can be seen that people tend to be risk averse when seeking profits, but rather risk-seeking when choosing to lose, which is contrary to the explanation of the expected utility theory, which considers only maximum utility.

Professor Kahneman created the forecast theory to explain the above phenomenon. People feel the pain of loss more than the joy of profit. When asked, ‘How much would it be balanced to lose 100 dollars at least?’ many people doubled to about 200 dollars. In several experiments that estimated the ‘loss avoidance rate’, people’s answers were usually between 1.5 and 2.5 times.

2. Selling ratio of profit position is twice higher than loss position

There are also interesting research results in Korea regarding stock investment. The ‘behavioral convenience and transaction behavior of domestic individual investors’ published by the Capital Markets Research Institute in 2022 studied the investment behavior of individual investors based on the daily transaction details of about 200,000 individual investors in the Korean stock market from March to October 2020. The study empirically analyzed the effects of four behavioral conveniences, such as overconfidence, disposal effect, lottery-type stock preference, and cluster transaction, on individual investors’ transaction behavior and investment performance.

In particular, the “disposal effect” refers to the phenomenon of realizing profits by selling when the price rises compared to the purchase price, and delaying and holding the sale when the price falls. The reason for the disposal effect is explained by the prospect theory that investors tend to hedge against profits and risk preference for losses.

According to the results of the study, regardless of the holding period, the selling ratio (blue line) of the profit position is about twice as high as the selling ratio (red line) of the loss position. In the case of a holding period of one day, 41% of the profit position was sold and 59% was held, but only 22% of the loss position was sold and 78% was held. In the case of a holding period of 10 days, 11% of the profit position was sold, while only 5% of the loss position was sold. This is the effect of the disposal effect.

The disposal effect explained by the prospect theory negatively affects investment performance. This is because the realization of profits too quickly eliminates additional profit opportunities and accumulates losses by delaying the realization of losses. In particular, losses often continue to increase when losses are not realized through loss-making.

3. The fundamental quality of making money is to tolerate loss

The Wizards of the Market by Jack Schweger, a best-selling author and hedge fund expert, is similar. Jack Schweger gained popularity by conducting in-depth interviews with outstanding traders in the investment sector and introducing their investments and strategies in a dense manner.

In the book, Dr. Van K. Tharp is the author of Investment Psychology Inventory, an experiment that measures the nature of winning and losing money, in 1982. Dr. Tharp said most traders fail to apply the two rules, explaining that “the two basic rules for success in speculative trading are to cut short quickly and maximize profits.”

Dr. Tarp emphasized that if making money is important to you (it is important to you, of course!), even small losses become more difficult to accept. As a result, small losses develop into significant losses that are more difficult to accept, eventually