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NISM Certifications · NISM-Series-X-B: Investment Adviser (Level 2) · Behavioural Finance in Practice

An investment adviser notices that a client refuses to sell a stock that has fallen 30% below purchase price, saying 'I will sell once it gets back to my cost.' Which behavioural tendency is most directly shown, and what is the adviser's most suitable first step?

The client shows the disposition effect, holding a loser until it reaches cost. The adviser should reframe the decision by asking whether the client would buy the stock afresh at today's price, which removes anchoring on the purchase price and focuses on future prospects.

  1. ADisposition effect; ask the client to evaluate the stock as if buying it fresh today at the current priceCorrect
  2. BOverconfidence; advise the client to trade more frequently to recover the loss
  3. CHerding; ask the client to follow the majority view on the stock
  4. DRecency bias; advise the client to extrapolate the latest price rise

Explanation

Holding losers until they recover to cost is the disposition effect, linked to loss aversion and anchoring on the purchase price. A useful debiasing step is to reframe the decision: would the client buy the stock today at the current price? Increased trading, following the crowd or extrapolating recent moves would worsen the problem rather than address it.

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