One thing you’ll learn about the stock market when you start investing is that there is a lot of formal and informal terminology to get to grips with.
There is one particular term that has negative connotations in the stock world, and that’s ‘bag holder’.
If you don’t know what a bag holder is in stocks, we’re going to explain what it means in this article. We will also be exploring the significance of bag holders in the stock market and how to avoid having this term applied to you.
What Is A Bag Holder?
‘Bag holder’ is a term that is applied to investors who, for a variety of reasons, are ‘left holding the bag’. Basically, these investors are holding security positions that are steadily decreasing in value.
The term is mostly used to refer to investors who continue to hold onto the investment despite the fact that it is becoming worthless.
In most cases, bag holders are retail investors. While all investors can become bag holders, it is more common for retail investors to end up in this position because they don’t have much knowledge of the stock market.
However, sellers can also be bag holders. This typically happens to short-sellers who expect the cost of the stock to go down but are met with increased demand instead. In this case, the buyer wins and the seller becomes the bag holder.
Why Do People Become Bag Holders?
There are many reasons why someone might become a bag holder when investing in stocks.
Some bag holders are simply neglectful and don’t monitor their stocks. This means that the value of their investments may decline without them realizing it until the stocks eventually become worthless.
Often, bag holding comes down to the concept of loss aversion. Basically, investors are often very reluctant to admit that they have lost money, which they would have to do if they decided to sell stocks that had decreased in value.
There is also something called the sunk cost fallacy. Basically, until the falling stocks have been sold, the lost money will not be reflected in the investor’s accounts.
Therefore, some investors have a tendency to hold onto failing stocks (see also ‘How Long To Hold Stocks‘) in the hopes that they will increase in value despite evidence to the contrary so that they don’t have to formally recognize the loss.
Why The Stock Market Needs Bag Holders
Clearly, from the information provided above, being called a bag holder is not a good thing. However, the reality is that the stock market needs bag holders in order to function the way it does.
Ultimately, market makers need investors to buy their stocks (whether they are valuable or not) so that they can continue to make money.
Therefore, they take advantage of the demand that increases as the cost of stocks rise and sell those stocks to buyers who don’t know better.
These buyers are then reluctant to let go of their investment as its value decreases and they become bag holders.
How Not To Be A Bag Holder
Nobody wants to be a bag holder, but if you don’t know much about investing in stocks, it could easily happen to you.
Luckily, you can follow these steps to ensure that you don’t become a bag holder for the stock market.
1. Learn The Stock Market Before You Invest
This really should go without saying, but if you don’t have a solid and in-depth understanding of how the stock market works, you’re more likely to lose money and end up as the bag holder.
If you don’t know how the stock market works, you can’t know how to make it work for you. This means that you’ll primarily be relying on luck to make money – essentially, gambling.
Before you invest in stocks, please take the time to do your research. There are plenty of beginner-friendly resources online, from YouTube videos to articles, so check these out first.
2. Buy In An Uptrend
Buying stocks that are high and selling them higher than you bought them seems like a risky maneuver, but it’s a strategy that has been recommended by famous and successful investor, Bill O’Neil.
O’Neil recommends looking for stocks that have increased, paused, and then continued to increase. This is an indicator of strength.
Many investors rely on their confidence that declining stocks will rally at some point in the future, but it’s very difficult to accurately predict this.
It’s much safer to invest in stocks that are already strong and demonstrate a likelihood of getting stronger.
3. Cut Your Losses
When you notice that your stock is showing signs of declining without any significant evidence that it will rally, you should cut your losses at the earliest opportunity.
It’s tempting to keep holding onto declining stocks for the psychological reasons outlined above, and it can definitely be frustrating to sell stock only to realize that it increased again after the fact.
But selling soon after you notice a persistent declining trend is the best way to avoid being a bag holder.
4. Don’t Average Down
Averaging down (buying more shares in stocks as they decline) is often touted as a smart strategy for investing in stocks, but it’s rarely profitable in the long run.
This is because averaging down is essentially based on the hope that the stock will rally in the future, and since there is no way of basing this on concrete evidence, it’s a risk that often stems from a reluctance to accept a loss.
Many people become bag holders as a result of averaging down, so avoid this strategy.
Conclusion
A bag holder is an investor who holds onto declining stock in the hope that it will eventually increase in value again. Most of the time, this doesn’t happen, and the stock becomes worthless, with the person holding the worthless stock being the bag holder.
People may become bag holders because they genuinely believe that the stock will rise, or because they fear admitting to a loss.
The stock market relies on bag holders, but nobody wants to be one. That’s why it’s important to fully understand the stock market before investing.
To avoid becoming a bag holder, you should also try to buy in an uptrend, cut your losses early, and refrain from averaging down.
If you enjoyed this article, you might enjoy our post on ‘What Does SMA Mean In Stocks?‘.
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