From Scientific American:
Imagine that your child’s private school tuition bill of $20,000 is due and the only source you have for paying it is the sale of some of your stock holdings. Fortunately, you got in on the great Google godsend and purchased 100 shares at $200 each, for a total investment of $20,000, and the stock is now at $400 a share. Should you realize your net gain by selling half of your Google stock and paying off your bill? Or should you sell off that Ford stock you purchased ages ago for $40,000 at its current value of $20,000?
If you are like most people (myself included), you would sell your Google stock and hang on to your Ford stock in hopes of recovering your losses. This would be the wrong strategy. Why would you sell shares in a company whose stock is on the rise, and hang on to shares in a company whose stock is on the decline? The reason, in a phrase, is “loss aversion,” and the psychology behind it does not fit the model of Homo economicus, that figurative species of human characterized by unbounded rationality in decision making.