Losses tend to have a greater emotional impact than gains. And as a result, we are willing to take much more risk to avoid losses than to secure gains. The relevance of this effect to investment decisions is obvious. This particular phenomenon, the willingness to take risks to avoid losses, has been used to explain why some people buy more shares of their losing stocks as the prices fall even farther. Because of the perception skew, investors are willing to take on more risk to avoid facing a loss than they are willing to take on in order to realize a gain.
Losses tend to have a greater emotional impact than gains.
As a result, we are willing to take on more risk to avoid losses than to secure gains. The important lesson here is that our instincts tend to be a less-reliable guide than we would like to believe. Trusting your gut when it comes to investments is unlikely to lead you to maximizing your risk-adjusted returns. Just remember that any such judgment, no matter how high you feel your level of confidence is, may well be wrong. Applications of Behavioral Finance Things to watch for in your own investment reasoning include excessive fund switching and avoidance of risk.