Financial Education

Consider an investor who buys a stock for $100 and sees it rise to $150 at the end of the year. The following year, the stock closes at $125. Whether the investor is likely to interpret the investment as a gain or loss depends on the reference point used. In general, investors tend to use relatively recent reference points, with some research indicating that investors favor the 52-week high.  This theory is supported by a study showing that employee stock option exercises nearly doubles when the stock rises past the previous 52-week high.

Source: Psychology of Investing, The (2nd Edition)

For more information, see all articles on: Behavioral Finance, Investing in Stocks, Portfolio Management, Research

See also:

Six Stages of Business Cycle Investing

Prospect Theory

Common Size Balance Sheets

Breakeven Spread Analysis

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