Beliefs drive investors more than preferences.

• Position: Your Life

If anything about individual investors was common knowledge, it was this: their emotions lead them to sell winning stocks too soon and hold onto losers too long. However, new research casts doubt on this widely held theory that individual investors' decisions are driven mainly by their feelings toward losses and gains. Researchers found evidence that decisions primarily are motivated by beliefs about a stock's future.

"The story is not about whether an investor hates losing or loves gains--it's not primarily a story about preferences," states Itzhak Ben-David, coauthor of a study published in the journal Review of Financial Studies. "It is a story about information and speculation. The investor has a belief about where a stock is headed and that's what he acts on. Investors act more on their beliefs than their preferences."

The researchers studied stock transactions, examining when investors bought individual stocks, when they sold them, and how much they earned or lost with each sale.

The result was a radical rethinking of why individual investors sell winning stocks and hold onto losers. The findings do not mean that investors do not have an aversion to losses and a desire to sell winners, but the trading data suggests that these feelings are not dominating their decisions.

"People have a variety of reasons for trading stocks, which may include tax issues, margin calls, and an aversion to losses. These all may play a role, but what we show is that beliefs are dominant for the trading of retail investors," notes Ben-David.

The tendency to sell winners too early and to keep losers too long has been called the "disposition effect" by economists. "The disposition effect has been well-documented. The question is what we make of it. A lot of people look at the data and interpret if as meaning that the typical retail investor is...