Budi Frensidy: Empty Wrappers in the Portfolio
Nino Eka Putra ~ PR of FEB UI
DEPOK – Monday (12/10/2020), FEB UI Professor of Finance and Capital Market, Budi Frensidy released his article which was published in the Kontan newspaper, in the Exchange rubric – Wake Up Call, page 3, entitled “Empty Wrappers in the Portfolio”. Here’s the article.
“Empty Wrappers in the Portfolio”
What are the main mistakes retail investors make on the stock market? There are those who say herding in buying stocks when the price goes up, aka buy on rumors, and selling them when the price is experiencing a correction, or the popular term is sell on facts.
Others say that the mistake of retail investors is panic selling. There is nothing wrong with the above answers. Maybe that’s what they experienced. However, investment literature notes that the mistake of retail investors is to sell the winners too soon and hold the losers too long.
According to Shefrin and Statman (1985), market players tend to keep loser shares for too long, while hotshot stocks are sold too quickly for profit taking. This happens on almost all exchanges of the world. This condition is called the disposition effect. Have you experienced this bias yourself?
Please check your investment portfolio. If there are more losers than winners, you have to admit that bias. Another alternative to testing this is to open up a record of the stock sales you have made over the past year.
If the shares you are selling are profitable more than you are losing, you certainly can’t avoid it. In other words, you realize more profits than losses.
Finally, there are other ways to determine whether you are affected by this effect or not. During this year, please compare the profits from the sale of shares with the profits in your portfolio. If the realized gain you get is greater than the unrealized gain, you are clearly affected by this disposition effect.
When Camerer and Weber (1998) conducted this research, they found that the three approaches above gave the same result, namely supporting this theory. Why does this condition occur?
In contrast to traditional financial theory, which says humans are risk averse, behavioral finance (BF) states that humans are actually loss averse, and not risk averse. The proof is, when the share price falls below the purchase price, retail investors tend to hold it, with the hope that the stock price will rise again and the losses turn into profits.
Various studies that have been conducted show that humans feel the losses far deeper and longer than the effects of profits with the same amount of money (Kahneman and Tversky, 1979). Everyone agrees that loss always brings sadness and disappointment, while gain brings satisfaction and pleasure.
However, the degrees of sadness and pleasure induced for the same monetary value are quite different. The loss effect of $500 is relatively greater than the effect of a $500 gain. The pain of losing $500 is equivalent to the joy of a $2,000 gain (see figure).
That is the essence of prospect theory, which earned Kahneman the Nobel Prize in Economics in 2002, and is the only psychologist who has won the Nobel Prize in Economics to date. That an investor is more likely to be loss averse and become a risk seeker in a loss area. The satisfaction (utility) curve in the region of gain is concave, while the utility curve in the region of loss is convex.
In stock investing, loss means choosing the wrong stock. Realizing a loss means admitting this mistake. If this wrong decision-making becomes known to others, the impact of admitting wrongdoing is even greater, because there is shame.
Other people are very likely to judge the ability of this investor to be lacking. This view is quite painful and reduces the self-esteem of an investor. Psychology teaches that humans tend to judge themselves positively and competently.
Furthermore, BF said that investors were also not willing to realize their losses because they wanted to minimize future regrets. Selling a loss stock opens the possibility of more regret at a later date if the share price goes up again.
On the other hand, realizing losses also precludes the possibility that the original decision, namely buying shares, was actually correct. That the investor is actually skilled and experienced.
If later the share price rises, the investor will not only suffer losses, but also experience enormous regret. The reason is, these investors will feel they have made two mistakes in a row.
First, he bought loser stock. Second, he gave up the shares at the wrong time. The effect of the second decision has deeper emotional consequences, far beyond the effect of the first decision. In order to minimize this regret, many investors have taken a defensive position with loser stocks.
The opposite is true for profitable stocks. There is an effect of pride and victory in investors from having made the right decisions in choosing stocks. Therefore, without waiting long, retail investors in general will soon realize the benefits.
The implication of this bias is that retail investors experience many small gains and no large gains on the one hand. On the other hand, there is a possibility that investors will experience large losses in addition to small losses.
A tip from me, let the profits run, not the losses. Let the profits, not the losses, continue to flow. This of course applies to normal conditions.
Currently, the condition of our stock market is under heavy pressure. Therefore, don’t be too sad if your portfolio contains empty wrappers. (hjtp)
Source: Kontan Newspaper. Edition: Monday, 12 October 2020. Bursa Rubric – Wake Up Call. Page 3.
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