The internet is full of statements by so called experts. In this series called Myth Busting we take a look at a number of commonly held beliefs in the market place and query our database to see whether these statements/beliefs are FACT or FICTION.
PsyQuation is in unique position to provide a definitive voice on this subject with one of the largest retail FX research databases. We have tried to remain as impartial as possible to the outcome and simply let the results speak for themselves. Let’s get started.
|Date Range||20 Oct 2008 — March 2018|
Disposition Effect is Bad
This is one of the classic behavioural finance bias’s. The simple definition is when a trader cuts their winners early and lets their losers run. There are a lot of academic superstars who hang their hat on this bias being bad for your trading.
There are also many gurus who claim the secret to trading success is cutting your losses early and letting your winners run. In theory this sounds like a good idea. The big question is whether this is what successful traders do in real life.
In the chart above the X axis represents the Disposition Effect ratio, the histograms are separated in different colours representing winning traders and losing traders, the magenta/purple represents where they overlap
When we do a scatter plot with the disposition effect ratio on the Y axis and the PNL of traders on the X axis we see no dependance, which means that based on the evidence we have before us its fiction to believe that the disposition effect is bad for you. It appears that one cannot apply a blanket understanding of the disposition effect bias and assume its bad for all traders. From what we can see is that most traders have a disposition effect (67%) and because we cannot find conclusive evidence that it is bad for your trading we can deduce that for some people this bias in fact suites their style and is good for their overall trading performance.
Don’t trust everything you read in an academic journal.