The Effect of Behavioral Finance on Stock Investment Decisions

According to Barberis & Huang, loss aversion refers to the difference level of mental consequence that people may have from a similar size loss or gain.

A number of studies on loss aversion argued that the possibility of a loss is on average twice as a powerful motivator as the possibility of making a gain of equal magnitude.

Loss aversion is a bias that simply cannot be tolerated in financial decision-making. It instigates the exact opposite of what investors want: increased risk, with lower returns. Investors should take risk to increase gains, not to mitigate losses.

Hassan et al. questioned the respondents about the type of investment stocks that they decided to invest in (fixed saving (no losses) or forex stocks). In addition, they depended on the same attitude that was applied by Kahneman & Tversky to measure loss aversion and the percentage of loss amount.

Chun & Ming measured loss aversion by using the following indicators:

1. Focus on large loss in stock than missing a substantial gain (profits).
2. Nervous feelings when large price drops have in invested stocks.
3. Refuse increasing investment when the market performance is poor.
4. When it comes to investment, no loss of capital (invested money) is more important than returns (profits).
5. Avoid selling shares that have decreased in value and sell shares that have increased in value.