The sunk cost fallacy is one of the most destructive mental traps in trading. It causes traders to continue holding losing positions or pursuing losing strategies simply because they have already invested time, money, or emotional energy. Learning to recognize and overcome this fallacy is essential for trading success.
What Is the Sunk Cost Fallacy?
The sunk cost fallacy is the tendency to continue an endeavor because of previously invested resources (time, money, effort) rather than based on future expectations. The "sunk" costs are resources already spent and cannot be recovered regardless of future actions.
In trading, the sunk cost fallacy appears as:
- Holding a losing stock because you have "already lost so much"
- Continuing to add to a losing position to lower your average cost
- Refusing to sell because of how much time you spent researching
- Sticking with a failing strategy because you spent months developing it
- Holding a position because of the commission costs you paid to enter
Key insight: What you have already lost or invested is gone and irrelevant to optimal future decisions. The only question that matters is: What is the best use of your current capital going forward?
How the Sunk Cost Fallacy Destroys Accounts
Throwing Good Money After Bad
A classic sunk cost mistake is averaging down on losing positions. You bought at $100, it dropped to $80, so you buy more to lower your average. Then it drops to $60, and you buy more. The logic feels sound - lower average cost! But you are compounding your exposure to a losing position. What started as a small loss becomes a catastrophic one.
Waiting for Breakeven
Traders fixate on recovering sunk costs. "I cannot sell until I get back to even." This ignores that your entry price has no bearing on the stock's future direction. While you wait for breakeven, you miss other opportunities, and the position may continue declining.
Justifying Time Investment
"I spent 40 hours analyzing this trade - I have to make it work." The time spent is a sunk cost. It does not make the trade more likely to succeed. But we feel compelled to justify that time investment by sticking with the trade even when evidence suggests we should exit.
Emotional Investment
Beyond money and time, we invest emotion in our trades. We become attached to our positions and our narratives. This emotional sunk cost makes it painful to admit we were wrong and move on.
The Compound Mistake
The sunk cost fallacy often combines with other biases. You average down (sunk cost), then anchor to your new lower average price (anchoring bias), then seek information supporting your position (confirmation bias). These compounding biases can lead to devastating losses.
Real-World Examples
The Bagholding Spiral
Consider a trader who buys 100 shares at $50 ($5,000 investment). The stock drops to $40. Instead of cutting the $1,000 loss, they buy 100 more shares ($4,000 more), lowering their average to $45. The stock drops to $30. They buy 200 more shares ($6,000), average now $37.50. The stock drops to $20. Their $5,000 initial investment has become $15,000 invested in a position now worth $8,000 - a $7,000 loss. Sunk cost thinking turned a $1,000 loss into a $7,000 disaster.
The Strategy That Once Worked
A trader develops a strategy that worked well for two years. Market conditions change, and the strategy starts losing. But after investing so much time developing and perfecting it, they cannot abandon it. They continue trading it, watching losses mount, thinking "it has to start working again." The time invested is a sunk cost, but they let it drive ongoing losses.
Signs You Are Falling for the Sunk Cost Fallacy
Watch for these thought patterns:
- "I have already lost too much to sell now"
- "I cannot give up after all the work I put in"
- "I just need to get back to even"
- "If I sell now, those losses become real"
- "I have been in this position for too long to exit now"
- "The commissions I paid mean I have to hold longer"
- "I owe it to myself to see this through"
Strategies to Overcome the Sunk Cost Fallacy
1. Understand That Sunk Costs Are Gone
Truly internalize this: money already lost cannot be recovered by holding the position. The loss is identical whether you sell now or later - the only question is what happens going forward. The sunk cost is sunk. Only future prospects matter.
2. Ask the Fresh Eyes Question
Pretend you have no position. Looking at this stock right now with fresh eyes, would you buy it? If not, why would you hold it? Your current position should only be held if it is where you would want to deploy capital today.
3. Consider Opportunity Cost
Capital in a losing position is capital that cannot be deployed elsewhere. Every day you hold a loser is a day you are choosing it over other opportunities. Frame the decision as: "Would I rather have this position or the cash to deploy in my next best idea?"
4. Use Pre-Defined Exit Rules
Before entering any trade, define exit criteria: stop loss levels, time limits, fundamental changes that would invalidate your thesis. When these criteria are hit, exit without debate. This removes sunk cost thinking from the decision.
5. Calculate the True Cost of Holding
What if, instead of holding a loser for six months waiting for breakeven, you had deployed that capital in index funds? Calculate what you gave up. This makes the opportunity cost concrete and counters the sunk cost focus.
6. Separate Decision Quality from Outcomes
A good decision can lead to a bad outcome due to randomness. Judge decisions by the process, not the result. If your analysis was sound but the trade did not work, that does not mean you should throw more resources at it.
7. Practice Cutting Losses
Deliberately practice taking small losses to build the habit. The more comfortable you become with exiting losing positions, the less power sunk cost thinking will have over you.
Track Your Exit Decisions
Pro Trader Dashboard helps you analyze your exits and identify patterns of holding losers too long.
The Positive Flip: Investing in Winners
Interestingly, the sunk cost fallacy can also work in reverse with winners. Traders sometimes sell winning positions too early because they have not invested much in them emotionally. "It was such an easy trade, I should take profits." Meanwhile, they hold losers because of all the effort invested.
The opposite approach is correct: cut losers quickly (regardless of sunk costs) and let winners run (regardless of how little effort they required).
Making Peace with Losses
Losses Are Tuition
Reframe losses as the cost of learning. Every loss teaches something. When you extract the lesson and move on, the sunk cost provides value. Holding forever hoping to recover provides nothing but continued pain.
The Clean Slate Benefit
There is psychological value in cutting a loss and moving on. The mental space consumed by a losing position is freed up. You can think more clearly about new opportunities. Sometimes the best thing a loss gives you is a fresh start.
Control What You Can
You cannot control whether a losing position recovers. You can control your decision to exit and redeploy capital. Focus on the actions within your control rather than hoping for external salvation.
Summary
The sunk cost fallacy causes traders to continue holding losing positions because of previously invested resources - money, time, and emotion. This leads to averaging down on losers, waiting endlessly for breakeven, and refusing to abandon failing strategies. Combat this fallacy by truly accepting that sunk costs are gone, asking the fresh eyes question, considering opportunity cost, using pre-defined exit rules, and practicing cutting losses. Remember that optimal decisions are based entirely on future expectations, not past investments. The resources you have already spent are irrelevant to the best path forward. Sometimes the wisest use of a sunk cost is to learn from it and move on.
Learn more: loss aversion in trading and managing losing trades.