According to Urban Dictionary, “bag holder” originated from the Great Depression. During this time, those in soup lines held their only possessions in potato bags. Over time, the term has evolved and made its way to mainstream Wall Street. There’s even a blogger – not me – who proposed starting a support group called “Bag Holders Anonymous.”
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A bag holder is a term we use to describe someone who holds a “bag of stock,” decreasing in value over time. But it could be crypto, forex, or even bonds they are “holding” while the price steadily drops. Ultimately, depending on their stubbornness and stupidity, they hold it until it is worthless.
Let me give you an example to illustrate. Investor Karen, eager to get in on a new tech start-up company, buys at the IPO’s high. At $25 a share, she buys 1000 shares, thinking the price will continue to skyrocket to the moon. Or, $75 at least.
Although the price did skyrocket during the IPO, it quickly plummeted. With people questioning the business model’s legitimacy and subsequent poor earnings reports, faith in the company is waning.
This is reflected in a swift fall from grace, with prices hovering in the $5 arena. Despite this ominous sequence of events, Karen holds onto her bag of “potato” stocks. In this scenario, Karen is a bag holder. You can even look at PetCo for an example.
It’s been falling since its IPO. You’re sitting pretty if you took the short play on that stock. But if you expected it to take off because the pet industry is billion-dollar, you’re out of luck.
Bag Holder Experience
Okay, I must admit I did this once. I bought a penny stock for pennies that shot up over $2.00. The price held for a while; I sold a portion, made bank, and bought some more, around $1.50 a share.
Eventually, I meant to sell the rest, but by the time I got around to doing so (life got in the way, and I forgot to sell), the price had plummeted to mere pennies.
No matter how many prayers I did, the price never went back up. It dropped so low it got delisted. I was your stereotypical bag holder extraordinaire.
Oh, and I forgot to mention that I didn’t realize I could claim the loss on my income tax and subsequently missed my window. The image above could be me, but I held the wrong type of bag. Too bad it wasn’t a multi-bagger! Agh.
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Psychology Behind Holding Losers
Have you heard of loss aversion and the disposition effect? Don’t fret if you haven’t, but they might explain the Karens of the world.
For starters, a bag holder may forget to check their portfolio, unaware of the fall in price. I guess that was me in the above example.
However, a more realistic explanation is related to the trader’s ego. Selling shares at a loss means acknowledging a poor investment decision on their behalf. It’s always best to bury your head in the sand, right?
Bag Holder Example
This is an example of the bag holding on the pot stock $ACB. Notice the stock was trading at $150, then created a double top failure. This trapped the bulls and left them holding the bag. It’s now trading at $0.45.
How to Avoid Bag Holding Stocks
You must be patient with your trades to avoid being a hag holder. Don’t jump in just because everyone else is. That’s one of the most common ways people get stuck with the bag. Hello, pump and dump penny stocks! What do the chart and fundamentals tell you? If you’re trading penny stocks, ensure the company has solid fundamentals so they don’t disappear and you’re stuck with shares you don’t want.
The Disposition Effect
Then, we refer to a little-known phenomenon called the disposition effect. You can be a victim of the disposition effect if you’ve prematurely taken profits or stubbornly held onto a losing investment.
The former is just as bad as the latter, as you’re leaving the massive bank on the table. In other words, people and traders psychologically hate losing money more than they enjoy making it. Sadly, the world’s Karens cling to false hopes and dreams that their losers will bounce back.
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The Prospect Theory
All of what I mentioned above is related to the prospect theory. The prospect theory explains how people decide what they perceive to gain, not lose. We tend to place a greater value on avoiding losses because of the associated negative emotional impact.
Prospect theory shows how people react differently based on risk and uncertainty. For example, imagine gaining $1,000 and then losing that same $1,000. Which causes a greater emotional reaction? You guessed it, losing the $1,000. Or what about the choice to receive $50 or $100 but then lose half?
Even though both scenarios result in a net of $50, most people choose the first option. Although they eventually stand to gain, the outgoing funds loom larger in their minds.
Final Thoughts: Bag Holder
Enter another way a trader may become a bag holder: The sunk cost fallacy. In financial terms, a sunk cost is a cost that has already been incurred and cannot be recovered. Economists would point out that the sunk cost fallacy is irrational and could be described as ” throwing good money after bad. “ Unfortunately, we continue to pursue something we have already committed. This commitment can be in money, time, or effort, even if the costs are not recoverable.
Suppose a trader bought 100 shares of Gamestop at $10 per share, costing $1,000. Due to news or some catalyst, the price falls to $3 per share. Your holdings’ market value is now $300; your $700 loss is considered a sunk cost. Sadly, many traders and investors wait for the price to soar back up to $1,000 in hopes of recouping their investment. But the losses are already a reality and should be considered permanent.
Finally, some refuse to accept reality and don’t sell at all. It’s still a loss, even though it’s unrealized.
