Disposition Effect, explained.
The disposition effect is a tendency to realise investment gains more readily than losses. A gain or loss relative to purchase price can become a reference point for deciding what to sell.
Why it happens
Realising a gain may feel like confirming a successful decision, while selling below purchase price makes a loss explicit. Neither feeling directly determines the asset's prospective payoff. Other reasons for selling, including taxes and diversification, can be valid.
The disposition effect is a tendency to realise gains more readily than losses. A purchase-price reference can influence selling even when it does not change the forward-looking opportunity.
Read the result
Choose which asset to sell across four cards. Paired cards preserve current and hypothetical future values while changing the purchase bases. Compare your own paired choices rather than treating the game as a diagnosis.
A worked example
Two assets with different forward opportunities
Both assets currently sell for 100, but this teaching card specifies next values of 120 for A and 80 for B.
Selling B and keeping A gives 100 cash plus 120 next-period value, a total of 220.
Swap the purchase-price labels while keeping those payoffs fixed. The forward-looking comparison remains 220 versus 180, though the realised-gain story changes.
OPTIONAL DEEPER DETAILGo deeper: inside the model
Inside this model
Each asset currently sells for 100. One has stipulated next-period value 120 and the other 80; which one is better alternates. Purchase bases change between paired cards while forward payoffs remain identical. Selling yields 100 plus the kept asset's next value. Choices and purchase gain/loss labels are recorded, not diagnosed.
Where this idea is useful
A practical use
Selling an asset simply because it shows a gain can discard the better forward-looking option in this deliberately transparent task.
A common misconception
“Selling a loser is always the right decision.”
The relevant comparison is forward-looking and context-dependent. A loss label alone provides no universal rule, just as a gain label does not prove an asset should be sold.
What this explanation leaves out
- The future values are supplied for learning, not forecasts. Taxes, liquidity needs, risk, and diversification can rationally affect a real sale; a few choices do not establish a psychological trait.
Why disclose the future values?
Doing so isolates the purchase-price reference in a transparent puzzle. Real future values are uncertain, so this is not a recommendation to predict a price and trade on it.
If you had no memory of your entry price, what evidence would support keeping or selling the position today?
Associated thinkers
Associations marked provisional are awaiting source review.
Further reading
Explore the original research or the teaching reference behind this experiment.