Dec 19, 2016 | by Franck Cushner, CFP®
Don’t throw good money after bad. It seems simple enough, but too often investors – instead of getting out of bad positions – increase their size as they lose money. The reasons can be numerous, but are primarily ‘rationalized’ as lowering the average purchase price – so you can either break even at a lower price or reap greater reward when the market goes your way. Well, quite frankly, the market doesn’t care about you being right and you won’t get rich waiting to prove it wrong. As famed economist, John Maynard Keynes, so eloquently put, “markets can remain irrational longer than you can remain solvent.” The nice thing about this quote is that it doesn’t force you to admit you’re wrong, just that you are ahead of the curve. Personally, I prefer to be wrong. It gives me a learning opportunity.
When things aren’t going your way, when you are losing money daily, weekly, monthly, and, heavens forbid, yearly, you are facing serious questions about your positions (and should be seeking out the answers). Well, until you figure out the meaning – get out. I’m not saying lose sleep over every five-minute price change (nor even daily fluctuations nor weekly, depending on your investing horizon), what I am saying is try to understand what is going on and do not double up. Rather, before you ever take a stance on a stock, figure out where you have doubts about your beliefs. Know where to get out before you get in. If you have three solid reasons for believing in a stock, you should have a list of ten situations when you are unsure – and will close your positon. The thought isn’t if all ten come true, it is when any one of the ten come true you are out the door. Establish an egress. When anything violates your original beliefs, or introduces new information, you have a designated path to safety. Typically, associated with these signals will be what is referred to a stop-order – a trade automated to occur at a set price (or signal) to close your position. These are a good way to force discipline on yourself. Be strong and be humble.
At the end of the day, some of the best investors are right six out of ten times (sometimes much less). These are people that have made a living in the stock market because they are able to protect their winnings by preventing large losses. While cash may be queen, discipline is what keeps the throne intact and the crown bejeweled. Protect yourself.
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