When you look at selling behavior in financial markets, the most robust empirical fact is familiar: people sell winners too quickly and hang on to losers too long. Traditional explanations lean heavily on prospect theory — loss aversion, an S-shaped value function, and so on. But a recent paper by Brettschneider, Bruno and Henderson prods us to rethink that narrative by focusing not on final outcomes but on reference points that form along the path of returns. The result is a more nuanced understanding of why retail selling behavior looks the way it does, and why simple psychological stories miss a crucial structural piece.

The Key Idea: Maximum Price as Reference

Most models take the reference point, the price against which gains and losses are judged as the purchase price. These researchers argue that for many investors, the maximum price achieved since purchase matters just as much, if not more. Call it the high-water mark. Instead of asking “How far am I above or below what I paid?”, investors are often asking “How much have I lost relative to the best I could have done?”

This matters because it changes the prediction for selling behavior dramatically. Under the standard purchase-price reference, prospect theory predicts gradual changes in selling propensity as returns move further into gains or losses. But if the salient reference is the maximum price achieved — especially if that max occurred in the recent past — then the psychological cost of realizing that you missed the best opportunity can dwarf the cost of locking in a loss relative to purchase price.

In the data, this shows up as asymmetry that prospect theory alone cannot explain.

Using detailed transaction records, the authors examine the selling propensity of investors across thousands of stocks and millions of trades. The key empirical pattern is:

• Selling spikes when a stock approaches its recent maximum price, even if the current price is still below the purchase price.
• Selling does not spike symmetrically around the purchase price alone.
• The propensity to sell depends not just on unrealized gain or loss but on distance from the benchmark maximum since purchase.

In plain terms: investors behave as if they are haunted not by how much money they are losing relative to purchase, but by how much they failed to capture relative to the best price history offered.

This creates a very different picture. A stock that sold off sharply after a high will induce selling even at prices that are losses relative to purchase, simply because the stock is recovering toward a remembered peak. Conversely, a stock that has quietly drifted upward without a standout high does not trigger the same urge to sell, even at similar returns.

Why does this matter? Because it explains why the disposition effect appears so asymmetric in the field: the traditional prospect model, which treats purchase price as the sole reference, systematically mispredicts when and why people sell. The high-water reference model does a better job explaining not only when investors sell winners, but also why many investors avoid selling losers — even when they are far underwater relative to purchase price — if the stock has never achieved a psychologically salient high.

It also aligns with behavioral notions of regret and anticipated disappointment: people don’t just fear losses; they fear missing out on gains they once saw but did not lock in. That’s a powerful motivator — and a powerful source of predictable behavior.

What does this mean for trading strategies?

1. Patterns around local highs matter. Stocks going into or out of recent peak levels attract selling pressure in ways not captured by simple momentum or mean-reversion models.
2. Behavioral flows are reference-dependent in time. It’s not just where the price is relative to purchase; it’s where it has been relative to recent peaks.
3. Backtests that ignore path history miss structural behavioral drivers. A strategy that treats every trade as independent of the price path will systematically misestimate both flows and volatility.

From a risk perspective, the high‐water benchmark gives us a way to anticipate liquidity squeezes at particular price levels — the points where memory and regret combine to trigger mass selling.

This is not just another behavioral tweak. It challenges a core assumption in how economists and traders conceptualize reference points. Instead of a static anchor fixed at purchase, markets operate with dynamic, high-water anchors shaped by price history. And for anyone who has ever watched a stock rally into a prior high only to get hit with a wave of selling, this should feel immediately familiar.

Disclaimer

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