Every investing handbook hands you the same rule, and it is a good one: cut your losers and let your winners run. It is so familiar it sounds like common sense. But Terrance Odean, then a finance professor at Berkeley, went looking for whether ordinary investors actually do it. In his 1998 study “Are Investors Reluctant to Realize Their Losses?” he pulled the trading records of roughly 10,000 brokerage accounts and measured how often people sold their winners versus their losers. The answer was the exact reverse of the rule. Investors realized their gains at a far higher rate than their losses: a proportion of 0.148 for winners against 0.098 for losers, so a stock in the black was sold about one and a half times as readily as one in the red. The handbook says ride winners and cut losers. The data says we cut winners and ride losers. That gap has a name.
It is called the disposition effect(the systematic tendency to sell the positions that have gone up and cling to the ones that have gone down, regardless of which is the better business to keep owning). Hersh Shefrin and Meir Statman coined the term in 1985, in a paper whose title says the whole thing: “The Disposition to Sell Winners Too Early and Ride Losers Too Long.” It is one of the most reliably measured mistakes in all of investing. And here is the part that should sting: the winners those investors sold went on to beat the losers they kept by about 3.4% over the following year. They weren’t trimming the weak and keeping the strong. They were doing it backwards, and paying for it.
What the brokerage records actually show
A first objection is reasonable. Maybe selling winners is smart rebalancing, or tax planning, or investors quietly knowing something about the company that the rest of us don’t. Odean checked each of those, and none survived. The selling wasn’t explained by rebalancing to a target. It wasn’t the cheaper-to-trade names getting dumped first. Most tellingly, it wasn’t vindicated by what happened next, because the stocks investors held onto kept underperforming the ones they let go. The one place a tax motive showed up was December, when American investors finally sold losers to harvest the deduction. Eleven months a year, the pattern held: lock in the win, nurse the loss.
The effect is not a quirk of a few reckless traders, either. In the household data it shows up almost everywhere you look, not in a handful of outliers. That is what makes it worth your attention. A bias that afflicts only the careless is a problem for other people. A bias that shows up in nearly everyone’s account is a problem for you, and the first step is admitting the handbook rule you nod along to is one you are probably breaking.
The purchase price is doing the damage
So why do careful people do the opposite of what they know is right? The mechanism comes from prospect theory, the model of decision-making Daniel Kahneman and Amos Tversky published in 1979 and that earned Kahneman the 2002 Nobel Prize in economics. Two of its findings do the work here. First, we judge outcomes as gains or losses against a reference point, and for a stock that reference point is almost always the price you paid. Second, loss aversion: a loss hurts roughly twice as much as an equal gain feels good, a ratio of about 2 to 1 that Kahneman found holds across wildly different settings.
Stack those two together and the backwards behavior becomes almost inevitable. A stock trading above what you paid sits in the “gain” frame, and faced with a sure gain we turn cautious, grab the profit, and lock it in before it can evaporate. A stock below what you paid sits in the “loss” frame, and faced with a sure loss we turn into gamblers, holding on for the recovery rather than accept the certain pain of selling. “I’ll wait until it gets back to even” feels like patience. It is loss aversion wearing patience as a costume. The decisive detail is that every one of these reactions is triggered by a single number that has nothing to do with the company’s future: the price you happened to pay. The market does not know your cost basis, and it does not care. The business will earn what it earns whether you bought at 60 or at 110.
For a Swiss investor the cost is especially pure. With no capital gains tax on private holdings, there is no tax reward for cutting a loser and no tax penalty for riding a winner. The whole calculation that gives Americans a December excuse simply isn’t there. Every disposition-effect trade is dead-weight psychology, a tax you pay to your own nervous system and to no one else.
A sell rule that never asks what you paid
Knowing about the bias does not fix it. Odean’s investors weren’t stupid; the pull just arrives in the moment, exactly when you have to decide. The only reliable defense is structural: take the decision out of the heated moment and make it in a calm one, in advance. That is what pre-committed sell criteria are. Before you buy, you write down the specific, falsifiable conditions under which you will sell, and you tie every one of them to the business, never to your cost basis. The thesis breaks if margins fall below a line for two straight years; the moat breaks if a named rival breaches it; you trim if the position grows past its target weight. The price you paid never appears on the list, because it has no place in the forward decision.
A rank-based sell rule does this almost by design. At Obermatt we score a company on its fundamentals relative to its true peers, the handful of similar businesses competing for the same capital, and express it as a rank from 0 to 100. A sell trigger written against that rank (“sell when the combined Value and Safety rank falls below 50”) fires on what the company is doing against its rivals, not on whether your position is green or red. The rank doesn’t know your purchase price and cannot be anchored by it. A winner whose fundamentals decay gets sold; a temporary loser whose ranks hold gets kept. That is the handbook rule, ride winners and cut losers, finally enforced by something that can’t feel loss aversion. It is the same logic behind insisting on a margin of safety when you buy: bind the rational version of yourself before the emotional one shows up.
The principle underneath all of it is plain: the price you paid is a fact about your past, not about the company’s future, and the sell decision belongs entirely to the future. The disposition effect is what happens when you let a number from your past run the decision. So do the one concrete thing that disarms it. Before your next purchase, write the sell conditions down, phrase every one in terms of the business rather than your cost, and read them, not your gain or loss, when the moment comes. The rest of the discipline lives in our full stock-picking walkthrough. Decide in the calm to bind yourself in the storm.