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

Caselet: Arjun sold a mutual fund unit at a profit within weeks of buying, but kept a falling stock for three years. He explains that he 'books profits quickly to feel good' and avoids closing loss-making positions. His adviser says this pattern reduces after-tax returns. Which behavioural concept describes selling winners too early and holding losers too long?

The pattern is the disposition effect: selling winners too early and holding losers too long. It stems from loss aversion and the wish to realise gains while avoiding the pain of realised losses. Endowment effect, gambler's fallacy and hindsight bias describe different tendencies.

  1. ADisposition effectCorrect
  2. BEndowment effect
  3. CGambler's fallacy
  4. DHindsight bias

Explanation

The disposition effect is the tendency to sell winning investments too soon and keep losing ones too long, driven by loss aversion and the desire for the pleasure of realised gains. The endowment effect is overvaluing what one owns; gambler's fallacy is expecting reversals in random sequences; hindsight bias is believing past events were predictable. Only the first matches the described pattern.

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