Researchers have observed in behavioral finance that the principle of representativeness can lead even sophisticated investors into making poor decisions. A Behavioral Framework for Expected Stock Returns . Good companies are, after all, to investor perception, similar to good stocks even if they are not exactly the same things. The Investor's Perceptions An investor's perceptions, whether positive or negative, can skew their cognitive judgment. The story of the general's decision illustrates how, as a rule, people are much more sensitive to losses than to gains.
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.