What Is a Bag Holder and How Does It Work?
A bag holder is a colloquial phrase for an investor who retains a holding in a security that steadily loses value until it becomes worthless. In most circumstances, the bag holder stubbornly holds on to their possession for a lengthy period of time, during which time the investment's value depreciates to nothing.
TAKEAWAYS IMPORTANT
A bag holder is a slang term for an investor who stays on to underperforming assets in the hopes that they would recover when the odds are stacked against them.
Bag-holding conduct is motivated by psychological factors: investors are more concerned with recouping losses than with reaping gains.
By being the final owners of a failed investment, bag holders are likely to lose money.
Bag Holders: An Overview
The phrase "bag holder" comes from the Great Depression, when individuals on soup lines carried potato sacks packed with their sole belongings, according to the website Urban Dictionary. The word has now become part of the current investment language. A blogger who covers penny stock investment joked about forming "Bag Holders Anonymous," a support group for penny stock investors.
An investor who retains a "bag of stock" that has lost value over time is referred to as a bag holder. Let's say an investor buys 100 shares in a freshly listed technological company. Although the stock price initially increases during the initial public offering (IPO), it swiftly falls as experts begin to doubt the business model's validity.
Poor earnings reports in the future indicate that the firm is in trouble, and the stock price drops even further. A bag holder is an investor who is adamant about holding on to the stock despite the grim turn of circumstances.
IMPORTANT; The disposition effect, often known as the sunk cost fallacy, encourages bag holders to cling to their positions for excessively lengthy periods of time.
The Disposition Effect and Loss Aversion
An investor may hang on to underperforming stocks for a variety of reasons. For example, an investor may completely disregard their portfolio and only become aware of a stock's deteriorating value when it is too late.
An investor is more inclined to stick onto a position since abandoning it would imply admitting to making a poor investment judgement in the first place. Then there's the disposition effect, which occurs when investors sell shares of an asset whose price rises early while stubbornly holding on to investments that fall in value. Simply said, investors despite losing more than they love winning, and as a result, they cling to the belief that their lost positions will recover.
This is related to the prospect hypothesis, which states that people make decisions based on perceived rewards rather than losses. This idea is demonstrated by the fact that individuals prefer to get $50 rather than $100 and lose half of it, even though both scenarios yield them $50 in the end.
Individuals may also refuse to work overtime hours since they may be subject to additional taxes. Despite the fact that they stand to benefit in the long run, the outgoing monies loom larger in their minds.
The Fallacy of the Sunk Cost
Another reason why an investor may become a bag holder is the sunk cost fallacy. Sunk costs are expenses that have already occurred and cannot be recovered.
Consider a $1,000 transaction in which an individual acquired 100 shares of stock for $10 each. If the stock drops to $3 per share, the holding's market value drops to $300. As a result, the $700 loss is seen as a sunk cost. Many investors are inclined to hold off on recouping their investment until the stock slingshots back up to $1,000, but the losses have already occurred and should be regarded as irreversible.
Finally, many investors hang onto a stock for too long since the decline in value represents an unrealized loss that is not recorded in their accounting until the transaction is completed. This clinging to life effectively postpones the inevitable.
Particular Points to Consider
There are a few techniques to determine whether a stock is a probable bag holder candidate in practice. For example, if a firm is cyclical, with its share price fluctuating in response to economic shocks, there's a good probability that weathering the storm will result in a share price reversal.
However, if a company's fundamentals are harmed, its stock may never recover. As a result, a stock's sector may indicate its long-term potential for outperformance.
