The disposition effect
In 1985, Shefrin and Statman named the tendency to sell winners too early and hold losers too long: the disposition effect. In 1998, Terrance Odean measured it on 10,000 brokerage accounts: investors realized their gains about 1.5 times more often than their losses.
In trading it takes a specific form: you pull in your target, close manually as soon as the trade is slightly green, but let your stop drift further when the trade goes against you.
Why it's so expensive
Your profitability depends on both your win rate and the ratio between your average win and average loss. Cutting winners shrinks the average win, without improving the win rate enough to make up for it. Example with a 50% win rate:
| Average win | Average loss | Result over 100 trades |
|---|---|---|
| 2 R | 1 R | +50 R |
| 1.5 R | 1 R | +25 R |
| 1 R | 1 R | 0 R |
| 0.8 R | 1 R | −10 R |
The same trader, with the same entries, goes from a profitable strategy to a losing one purely through how they exit. The win rate and risk-reward guide walks through this calculation.
Measuring it in your trades
Two numbers are enough: the average duration of your winners and that of your losers. If your losers last clearly longer than your winners, the disposition effect is probably at work. Also compare your average win with the target you set at entry: a regular gap points to early exits.
The free diagnostic compares how long your winners and losers last, and checks what you believe about your exits against what your trades say.
Fixing it
- Set the target at entry and only move it according to a written rule, never on a hunch.
- Exit in two steps: part at the target, the rest with a trailing stop. It's a compromise that reduces the temptation to close everything.
- Don't watch your open P&L: hide it if your platform allows. The dollar figure triggers the urge to bank it.
- Review your cut trades each week: what would they have made at the original target? Your trading journal answers in minutes.
FAQ
Why do we cut winners too early?
Out of fear of seeing a gain disappear: the satisfaction of banking it is immediate, while the missed profit is invisible. It's the disposition effect described by Shefrin and Statman in 1985.
How do I know if I cut my winners too early?
Compare the average duration of your winners and losers, and your average win with the target set at entry. Short winners and long losers are the classic sign.
Should I always let my winners run?
No: you should exit according to a rule decided in advance. The problem isn't exiting early, it's exiting out of fear, inconsistently.
Sources
- Shefrin and Statman, "The Disposition to Sell Winners Too Early and Ride Losers Too Long", The Journal of Finance, 1985
- Odean, "Are Investors Reluctant to Realize Their Losses?", The Journal of Finance, 1998