Anyone who actually knows when to cut investing losses would be filthy rich. The other side of this coin is knowing when to sell your investments for gains. That is the entire name of the investing game. “Know when to hold ‘em; know when to fold ‘em.”
People spend hours looking at charts, using proprietary software, watching trends, following the news to try to gauge investor sentiment, and talking to their astrologer. But unless you are Goldman Sachs and have the game rigged, investing is a gamble.
Greed & Fear
As we have been told over and over again, investing is a game that swings back and forth between greed and fear. Greed causes us to hold our stocks too long, trying to hit the exact high. Fear causes us to sell our stocks too soon, believing it will continue to go down.
There isn’t a stock investing expert, dead or alive, who has never been burned at either end of this swing and usually at both ends on many occasions. One doesn’t make money investing by being able to exactly call highs and lows. The smart money sets goals for buying and selling and sticks to those goals.
If you are selling, you set a goal for your sale. If it is 25%, then you sell at a 25% gain. If it goes higher after you sell, you have no regrets. You still got your goal of 25%. If your stock is going down, you decide ahead of time at what point you will sell and you will sell at that point regardless of what happens after your sell.
Watching your stock over time should help you to understand when a loss in stock value is just a normal correction and when it is really heading south for good.
Investing in stocks requires a cool hand. Emotions inevitably cloud your thinking and will almost always cost you money.
Stop & Limit Orders
There is one way to protect yourself from your own greed and fear. Used intelligently and judiciously, this can save your bacon. Say you own a stock and you are concerned about it going down precipitously. You can put in a stop order or stop loss order.
A stop loss order essentially tells your broker to sell the stock automatically if it reaches a certain price, a price you set. If the stock drops to your stop price or lower, it will trigger a sell.
One has to be careful with stop loss orders because they can be triggered by a dip during the day that might not represent a real decrease in the stock value. A stop loss order should probably be at least 10% below the current market value.
On the other side of the trade are limit orders. Limit orders are used to buy or sell stocks. If I’m buying, I can tell the broker I want to buy a stock if it gets down to a certain price. Again, this order will be filled automatically if and when the stock makes your limit price.
If selling a stock, your limit order will tell the broker to sell if your stock goes up to your predetermined price level. These techniques take the emotion out of buying and selling but must be used judiciously. They don’t guarantee great success but can be a protection against selling too low or buying too high.
Selling Dead Stocks
Another emotionally challenging way to cut your losses is to sell dead stocks. These are stocks that are languishing, neither going up or down much over a long period of time. No one likes to sell a stock at a loss but there are times when it is the smart thing to do.
The motivation for me to sell some of my stocks at a loss was two-fold. I knew that taking some losses would help me at tax time. But the stronger motivation was that I wanted to buy some new stocks that I thought were promising. I didn’t want to pour more of my hard-earned cash into these stocks. So by selling some dead stocks, even at a loss, I freed up some cash and was able to re-invest in stocks with a chance to make a profit.
This has so far turned out very well for me. Again, you must put your emotions aside, bite the bullet, and deliberately take a loss. The big boys and girls lose money all the time. It’s not about always making a profit. It is about making a profit more often than you suffer losses.
I have been quite surprised by how unemotional I can be about the ups and downs of my investments. I tend to think of it as Monopoly money. The amounts of money I can gain or lose in one day, one week, or more would have made me go weak in the knees only a few years ago.
With a well-diversified portfolio, losses are just part of the game and you are not concerned about the daily, weekly, or monthly gains and losses. You are watching bigger trends and longer time periods.
You can make yourself crazy micro-managing your portfolio. How did your investments do for the year? Look at what is working and what is not and make adjustments based on the long haul. Educate yourself on the various sectors and see what looks good over the long-term.
It’s an old saying but it still holds some juice, don’t invest more than you are willing to lose. The bulk of your money should be in safe and reliable earning vehicles, savings, money market, CDs, and perhaps bonds for now. Your stock investments are high risk by definition.
Detach yourself from the outcome and have fun with your investing. It really is just a game. Don’t get too emotionally involved. Learn from your losses and you will become a better investor as time passes.