According to Urban Dictionary – the term “bag holder” originates from the Great Depression. It was during this time that those in soup lines held their only possessions in potato bags. Over time the term has evolved and made it’s way to mainstream Wall Street. There’s even a blogger – not me – who proposed starting a support group called “Bag Holders Anonymous.”
A bag holder is a term we use to describe someone who holds a “bag of stock,” decreasing in value over time. But it could be crypto, forex, or even bonds they are “holding” while price is steadily dropping. Ultimately depending on their stubbornness and, or stupidity, they hold it until it is worthless.
Let me give you an example to illustrate. Investor Karen, eager to get in on a new tech start-up company, buys right at the IPO’s high. At $25 a share, she buys 1000 shares thinking the price will continue to skyrocket to the moon. Or, $75 at least.
Although the price does skyrocket during the IPO, it quickly starts to plummet. With people questioning the business model’s legitimacy and subsequent poor earnings reports, faith in the company is waning.
This is reflected in a swift fall from grace, with prices hovering in the $5 arena. Despite this ominous sequence of events, Karen holds onto her bag of “potato” stocks. In this scenario, Karen is a bag holder. You can even look at PetCo for an example.
It’s been falling since its IPO. Now if you took the short play on that stock, then you’re sitting pretty. But if you expected it to take off because the pet industry is a billion-dollar one, then you’re out of luck right now.
I’ve Held Bag of Stocks Before (Sigh)
Okay, I must admit I did this once. It was a penny stock which I bought for pennies, and it shot up over $2.00. The price held for a while; I sold a portion, made bank and bought some more, around $1.50 a share.
Eventually, I meant to sell the rest; but by the time I got around to doing so (life got in the way, and I forgot to sell), the price plummeted to mere pennies.
No matter how many prayers I did, the price never went back up. In fact, it dropped so low it actually got delisted. I was your stereotypical bag holder extraordinaire.
Oh, and I forgot to mention that I didn’t realize I could claim the loss on my income tax and subsequently missed my window. The image above could be me, but, I held the wrong type of bag. Too bad it wasn’t a multibagger! Agh.
The Psychology Behind Holding Losers
Have you heard of loss aversion and the disposition effect? Don’t fret if you haven’t, but they just might explain the Karen’s of the world.
For starters, a bag holder may forget to check their portfolio, unaware of the fall in price. I guess that was me in the above example.
However, a more realistic explanation is related to the trader’s ego. Selling shares at a loss means acknowledging a poor investment decision on their behalf. It’s always best to keep your head buried in the sand, right?
How to Avoid Bag Holding Stocks
If you want to avoid being a hag holder, you need to be patient with your trades. Don’t jump in just because everyone else is. That’s one of the most common ways people get stuck with the bag. Hello, pump and dump penny stocks! What do the chart and fundamentals tell you? If you’re trading penny stocks, make sure the company has solid fundamentals so they don’t disappear and you’re stuck with shares you don’t want.
The Disposition Effect
And then, there’s a little-known phenomenon we like to refer to as the disposition effect. You can count yourself a victim of the disposition effect if you’ve ever prematurely taken profits or stubbornly held onto a losing investment.
The former is just as worse as the latter as you’re leaving massive bank on the table. In other words, people and traders psychologically hate losing money more than they enjoy making it. Sadly, the Karen’s of the worlds cling on to false hopes and dreams that their losers will bounce back.
The Prospect Theory
All of what I mentioned above is related to the prospect theory. Practically speaking, the prospect theory explains how people decide what they perceive to gain, not lose. We tend to place a greater value on avoiding losses because of the associated negative emotional impact.
Prospect theory shows how people react differently based on risk and uncertainty. For example, imagine gaining $1,000, then losing that same $1,000. Which causes a greater emotional reaction? You guessed it, losing the $1,000. Or, what about the choice to receive $50 or $100 but then lose half?
Even though both scenarios result in a net of $50, most people go with the first option. Although they eventually stand to gain, the outgoing funds loom larger in their minds.
Have You Heard of the Sunk Cost Fallacy?
Enter another way a trader may become a bag holder: The sunk cost fallacy. In financial terms, a sunk cost is is a cost that has already been incurred and cannot be recovered. Economists would point out that the sunk cost fallacy is irrational and could be described as ” throwing good money after bad “. Unfortunately, it’s our tendency to continue to pursue something that we have already committed. This commitment can be in the form of money, time, or effort, even if the costs are not recoverable.
Suppose a trader bought 100 shares of Gamestop at $10 per share, costing $1,000. Due to news or some catalyst, the price falls to $3 per share. As it stands, your holdings’ market value is now $300, and your $700 loss is considered a sunk cost. Sadly, many traders and investors wait for the price to soar back up to $1,000 in hopes of recouping their investment. But the losses are already a reality should be considered permanent.
Finally, there are those who refuse to accept reality and don’t sell at all. It’s still a loss, even though it’s unrealized.
