Risk aversion or loss aversion is another bias that refers to people’s tendency to prefer avoiding losses instead of equivalent gains. Studies suggest that the pain of losing money is twice as powerful as the happiness from gaining same amount of money.
This is the reason why most investors in India prefer investing in fixed income assets such as bank deposits, bonds, money market instruments rather than stocks, gold and mutual funds.
While protecting your losses is not a bad idea, allowing risk aversion to dominate your investment decision can deprive you of higher return on investment.
Most new and inexperienced investors have a strong loss aversion bias. As soon as a stock goes below their purchase price, investors panic and sell the stock, bailing out to safety, fearing a perceived loss.
The best way to avoid risk aversion is to avoid short term thinking and focus on the long term outcomes of investment.
Selling a good stock just because you are losing money does not make a good investment strategy. By analyzing a stock properly, and focusing on the facts rather than popular opinion(herd mentality), and long term prospects rather than short term volatility is the best way to prevent yourself from falling into risk aversion trap.