Sunk Cost Fallacy

The sunk cost fallacy is the tendency to keep investing time, money or effort into something because of what has already been spent, rather than because of what is likely to happen next. A sunk cost is money that is gone and cannot be recovered whatever you decide. Rationally, it should play no part in the decision. In practice, it plays a huge part, and trading is full of examples.

The idea in one sentence#

The only question that matters for an open trade is: "Given everything I know now, is this the best use of this capital from here?" The price you paid, the hours you spent researching and the loss you are currently sitting on do not change the answer.

How it shows up in trading#

Sunk cost vs related biases#

These biases often travel together, but each describes a different piece of the problem:

• Loss Aversion explains why losses hurt so much that we avoid realising them.
• Disposition Effect is the visible result: selling winners too early and holding losers too long.
• Anchoring makes the entry price feel like a meaningful level.
• Sunk cost fallacy is the reasoning that ties them together: "I've already put so much in."

Averaging down#

Adding to a losing position is not always a mistake. Some planned strategies scale in at predefined levels with total risk set in advance. The sunk cost version is unplanned: adding to a loser to lower the average price so that break even feels closer, without a fresh reason to buy. This can turn a small mistake into a large one, because each add increases exposure to an idea the market is already disagreeing with. See Scaling In and Pyramiding.

Beyond individual trades#

The sunk cost fallacy also affects bigger decisions:

• Sticking with a strategy that has clearly stopped working because of the time spent building it. See Why Strategies Fail.
• Keeping a broker, platform or subscription because of past payments.
• Continuing to trade a market you have studied extensively even after evidence shows you do not have an edge there.
• Refusing to close a trading account in drawdown because closing it would make the loss feel final.

In each case, the honest question is the same: what is the best choice from here, with what you now know?

How to break the sunk cost fallacy#

1. Use the fresh eyes test: "If I had cash instead of this position, would I buy it now?"
2. Set exits before entry so the decision is made before any loss exists. See Stop Loss Strategies.
3. Plan any scaling in advance with a total risk limit. See Position Sizing.
4. Separate effort from outcome: research time is a learning cost, not a reason to hold.
5. Review closed trades to see how often holding losers made them worse. See Post-Trade Analysis.
6. Hide the entry price in your platform's position display if it helps you focus on current value.

Common mistakes#

• Holding to break even rather than to a planned exit.
• Unplanned averaging down on losing trades.
• Keeping a failed strategy because of the work already put into it.
• Trying to win back losses quickly, which slides into Revenge Trading.

Frequently asked questions#

What is the sunk cost fallacy in trading?#

Making decisions based on money or effort already spent and unrecoverable, such as holding a losing trade because of the loss already taken.

Is averaging down a sunk cost fallacy?#

It can be. Planned scaling with fixed total risk is a strategy; unplanned adding to a loser to feel closer to break even is the fallacy.

How do I stop the sunk cost fallacy?#

Ask whether you would enter the position today with fresh cash, set exits before entering and judge each decision on future prospects only.

Next, learn how one number can take over your judgement: Anchoring.

Sources#

• Wikipedia, Sunk cost