A bag holder is a financial slang used to describe an investor who holds on to poor-performing, or worthless, investments. Bag holders tend to stubbornly hold their losing investments for an extended period instead of cutting losses.
A bag holder is an individual that holds on to poor-performing investments.
The main reason investors become bag holders is that they are unwilling to acknowledge a poor trade and realize a loss.
Conducting sufficient research on an investment and having an exit strategy is key to avoiding becoming a bag holder.
Why Do Investors Become Bag Holders?
One of the main reasons why investors become bag holders is that they are unwilling to acknowledge a poor trade and realize a loss. Investors do not enjoy losing money on their trades (attributable to the loss aversion bias), and when their investments start declining in value, they stubbornly keep holding in hopes that they will eventually generate a gain or at least break even.
Such behavior is commonly referred to as the disposition effect, defined as the tendency for investors to hold onto losing trades for too long, and exit profitable trades too quickly, where people avoid realizing paper losses but seek to realize paper gains.
Where Did the Term “Bag Holder” Originate From?
A theory is that the term “bag holder” dates back to The Great Depression, when people in the queues of soup kitchens and breadlines were holding potato bags. The term’s since been expanded to the modern-day investment dictionary to refer to people who hold poorly performing or worthless investments.
How Do You Know if an Investment is a Bag Holding Candidate?
Generally speaking, an investment is a bag holding candidate if it possesses any of the following characteristics:
Significant retail investor hype with no supportive fundamentals
A poor business model
Questionable/Dubious accounting practices
Bad management team
Deteriorating financial position
Deteriorating economic moat
Deteriorating market share
Increased in value substantially on no fundamental news
Enron is an example of a bag holding stock. The company’s share price declined from a high of $90 in 2000 to $0.12 two years later due to a series of dubious accounting practices.
Who is Most Susceptible to Becoming a Bag Holder?
Although any type of investor can become a bag holder, it is commonly understood that retail investors with limited investing knowledge are more likely to become one. It is because they may invest in securities based on word of mouth without doing their own due diligence.
For example, a significant number of retail investors became bag holders in meme stocks due to (1) their lack of research on the securities they were purchasing, (2) the “fear of missing out” (due to significant social media hype), and (3) the inability to develop an exit strategy when their securities started declining in value.
How to Avoid Becoming a Bag Holder?
Conducting sufficient research on an investment before investing is key to avoiding becoming a bag holder. It generally involves doing a deep dive on the company’s fundamentals, determining the attractiveness of the company’s competitive landscape, and its prospects for success.
Of course, there may be unexpected events that can cause a company’s share price to deteriorate (for example, a black swan event). As a result, it is also essential to develop an exit strategy (such as a stop-loss price) for the investment in question.
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