The Emotional Trap: Why Investors Chase Losing Investments and How to Avoid It

Have you ever found yourself doubling down on a losing investment, hoping to just break even? If so, you’re not alone. A surprisingly common mistake in investing is the tendency to chase past losses. But why do so many people fall into this trap, and more importantly, how can you avoid it?

Imagine you’ve invested in a particular stock, and instead of going up as you hoped, its value starts to decline. Instead of selling and cutting your losses, you might be tempted to buy more of that same stock. The thinking often goes something like this: “It’s down now, so it’s cheaper. If I buy more, when it goes back up, I’ll make even more profit, or at least get back to where I started faster.” This is the essence of chasing losses. It’s driven by a powerful mix of emotions and psychological biases that can cloud our judgment and lead to poor financial decisions.

One of the biggest drivers behind loss chasing is loss aversion. This is a well-documented psychological phenomenon that describes how humans feel the pain of a loss much more strongly than the pleasure of an equivalent gain. Losing $100 feels significantly worse than the joy of gaining $100. When an investment starts to lose money, this pain kicks in, and our natural instinct is to try and avoid that pain. Chasing losses can feel like a way to “fix” the situation and erase the painful loss, even though it might actually be making things worse.

Another powerful bias at play is the sunk cost fallacy. This is the idea that we tend to continue investing in something simply because we’ve already invested time, money, or effort into it, even if it’s clearly not working out. Think of it like this: you buy a movie ticket, but ten minutes into the film, you realize it’s terrible. Do you leave and accept the lost ticket money, or do you stay and endure the rest of the movie just because you’ve already paid for it? In investing, the sunk cost fallacy makes us reluctant to sell a losing investment because we don’t want to “admit” the initial investment was a mistake and realize the loss. Instead, we might pour more money in, hoping to somehow justify our initial decision and recover our losses.

Furthermore, hope and optimism can be dangerous in investing when unchecked by logic. We might tell ourselves, “It has to go back up eventually,” or “This is just a temporary dip.” While markets do fluctuate, and sometimes investments do recover, relying solely on hope without a sound investment strategy is risky. Chasing losses often stems from an overly optimistic belief that things will magically turn around, even if the underlying reasons for the investment’s decline haven’t changed, or have even worsened.

Finally, regret aversion plays a role. Selling a losing investment means acknowledging a mistake and locking in the loss. This can be emotionally difficult. By chasing losses and holding onto the investment, we can avoid that immediate feeling of regret. We might tell ourselves, “If I sell now, and it goes up later, I’ll regret it even more.” However, this fear of future regret can trap us in a cycle of poor decisions, potentially leading to even greater losses down the line.

In short, chasing losses is a deeply human, emotionally driven reaction. It’s fueled by our aversion to pain, our reluctance to admit mistakes, and our tendency to cling to hope. However, in the world of investing, emotions can be your worst enemy. Sound investment decisions should be based on careful analysis, diversification, and a well-defined strategy, not on emotional reactions to market fluctuations.

To avoid the trap of chasing losses, it’s crucial to have a clear investment plan from the outset, including your risk tolerance and exit strategies. Don’t let emotions dictate your actions. Regularly review your portfolio, and be willing to cut your losses if an investment is not performing as expected and no longer aligns with your strategy. Remember, accepting a small loss can sometimes prevent a much larger loss later on, and free up capital to invest in potentially better opportunities. Seeking advice from a qualified financial advisor can also provide valuable perspective and help you make more rational, less emotionally driven investment decisions.