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As portfolio values fall, investors may cling to losing stocks, sell winners and take bigger risks to try to recover.

Choy Jung-hyuck

The author is a professor of economics, finance and asset management at Hanyang Cyber University.

The Kospi, which reached an intraday record high on June 19, had fallen about 46 percent by Nov. 6. Over the same period, retail investors purchased a net 36 trillion won ($25 billion) worth of shares on the main stock market. Because they bought heavily during the downturn, many are likely holding portfolios with substantial unrealized losses. Market crashes typically raise fears of panic selling. Yet an opposite danger deserves equal attention: As losses deepen, investors may become increasingly reluctant to sell their losing stocks.

Behavioral finance calls the tendency to sell winning stocks readily while holding on to losing ones the disposition effect. A 2024 study by Professor An Li of Tsinghua University and fellow researchers extended that concept: It found that decisions about selling an individual losing stock depend not only on that stock’s performance but also on the gains or losses across an investor’s entire portfolio.

Among U.S. retail investors whose overall portfolios were profitable, the likelihood of selling a winning stock was 1.21 times that of selling a losing stock. When their portfolios were underwater, the ratio climbed to 2.14. In China, the corresponding ratio rose from 1.73 to 3.56. In other words, investors become particularly unwilling to realize losses on individual holdings when their portfolios as a whole are already losing money. The researchers also found that the disposition effect intensified when stock markets had performed poorly over recent quarters.

Why does this happen? Investors evaluate individual holdings and their total portfolio simultaneously. When the portfolio is profitable overall, accepting a loss on one stock may feel manageable. Gains elsewhere provide a psychological cushion. But when the entire portfolio is losing money, selling another stock at a loss can feel like admitting once again that an investment decision was a mistake. The reluctance reflects more than a calculation of future returns; it is also a response to the discomfort of acknowledging failure.

Such behavior can undermine risk management during a market plunge. If investors sell their profitable holdings first and retain their losers, the remaining portfolio may become increasingly concentrated in particular companies or industries. That can leave them more vulnerable to another downturn, especially when the struggling holdings share similar economic or business risks. The situation may worsen when the desire to recover losses begins driving investment decisions.

Research by Nobel Prize winning economist Richard Thaler suggests that people who have suffered losses can become more attracted to risky choices offering a chance to break even. The same psychology may encourage averaging down, the practice of buying additional shares after a stock’s price has fallen. Although doing so reduces the average purchase price per share, it also increases the amount invested. If the stock declines further, potential financial damage also grows accordingly. A lower average cost does not, by itself, make an investment safer nor improve a company’s prospects.

During a sharp market decline, investors should therefore examine the structure of their entire portfolio before focusing on the profit or loss of each stock. They need to review the weight of individual holdings and sectors, identify excessive concentrations and consider selling losing positions when the original investment rationale has weakened. Decisions to buy more should likewise rest on expected future returns and risks, not simply on a desire to lower the average purchase price or recover past losses.

This distinction matters because a stock that has fallen sharply is not necessarily cheap, just as a stock showing a gain is not necessarily overvalued. The price originally paid is a historic reference point, not a reliable measure of what the security is worth today or tomorrow.

No one knows when the market will rebound. What investors can decide is which assets and exposures they will carry until that recovery arrives. In a falling market, the priority should not be protecting losing positions from the discomfort of a sale. It should be preserving the health and resilience of the portfolio as a whole. Only then can investors remain positioned to benefit fully when markets eventually recover.