How Do Limit Orders Affect the Disposition Effect on Highly Liquid Markets – Experimental Finance Evidence

Abstract

We examine the effect of selected limit order tools (stop loss, take profit, and trailing stop) on the disposition effect, a well-known behavioral bias, by using experimental trading data. Our presumption is that the limit orders should significantly eliminate this behavioral bias, which may lead to higher losses than feasible for a trader. The traders of our data sample can be considered as a sample of beginners or less informed traders. Based on our analysis it is possible to conclude that limit orders have a significant impact on the disposition effect. Traders using these tools were able not only to avoid this behavioral bias, but even reverse it, which is, as far as we know, a unique result within the existing literature. Moreover, we found out that the impact of eliminating of the disposition effect by limit orders use is positive, as it may lead to significant loss reduction. On the other hand, the effect on profits is insignificant.

Keywords:

• Behavioral finance
• Experimental finance
• Limit orders
• Disposition effect
• Behavioral bias

Notes

1 Contracts for Difference of commodities, indices, bonds, and metals

Additional information

Funding

This work was supported by the Czech Science Foundation (GAČR) under Project GJ20-25660Y, and SGS Research Project SP2021/15 of VŠB–TU Ostrava. The support is greatly acknowledged.