Understanding the Concept of the Crypto Disposition Effect

• The Crypto Disposition Effect is the situation that affects investors’ interests.
• This is embedded in human nature, which is why it cannot be eliminated. However, it can be tamed according to the investor’s will.

What is the Crypto Disposition Effect?

In a 1985 paper, Hersh Shefrin and Meir Statman coined the term, “the disposition effect”. It meant that in terms of investments, investors tend to sell their winners too early and hold their losers for a longer period of time.

In today’s world, the majority of investors suffer from the disposition effect, which stands in the way of capital efficiency and prevents them from earning optimum profits.

If we talk about how disposition affects humans, then we first need to understand that humans, by nature, are loss averse. For example, losing $100 will cause you more displeasure than gaining the same $100. 

As per the prospect theory, it is most likely that individuals will choose those choices that may result in gains and will repel those choices that may result in losses. For instance, if a person is presented with two options:

• 50% possibility of winning $100,000 or nothing.
• $10,000 is guaranteed to be the prize.

The likelihood that the person will select the second choice, which ensures victory, is the highest. If we apply the same logic to crypto trading, a trader will most likely exit the situation once they have guaranteed the profit without risking their entire portfolio for more.

A recent paper by Steven Haryanto and Athor Subroto states that “there’s a reverse disposition effect in bullish markets and a positive disposition effect in bearish markets”. In simpler terms, it means that investors tend to hold their winners for a longer time in bullish markets but sell them early in bearish markets.

This explains why many Bitcoin investors bought BTC way lower than its peak in 2021, and still continue to hold it to this day despite it losing 70% of its value. In the same way, it explains why almost no trader could capitalize on Shiba Inu’s 25 million percent growth in 2021 due to selling it early.

Ways to Avoid Disposition Effect

Since this effect is part of human nature, it is tough to tame it according to our will, but it’s possible. By employing various strategies, you can determine the appropriate moment to enter or exit the market.

• Broad Framing

Most traders like to manage their trades on a case-by-case basis. This strategy can be beneficial if done right; however, it leads to traders often giving too much attention to the outcome of a single trade. This can lead to the trade outcome looking bigger than it really is when, in fact, it’s just part of a bigger picture.

By flipping the picture, you can see it for what it really is – a small part of a bigger plan. This is called Broad Framing. The goal of an investor should be to earn gains on their overall portfolio instead of focusing on individual trades. Making decisions based on this ideology can lead to more informed decisions.

• Strategy Automation

It is often said that an investor’s biggest enemy is not the crypto market but his own emotions. The disposition effect only affects a person because they are emotionally or illogically attached to their investments. This can be removed by removing emotions through automation.

This simply means automating your trading activity. An investor can set conditions for the sale or purchase of any asset based on the latest analysis, limit their losses and enhance their gains.