How to Handle Stock Losses
By Michael Cintolo, Editor of Cabot Market Letter and Cabot Top Ten Report
From Cabot Wealth Advisory 4/19/09 Sign up for free Cabot Wealth Advisory e-newsletter
One of the reasons I love the stock market (though sometimes it's more of a love-hate relationship) is that it's such a battle of the mind. Of course, few pundits or analysts will tell you that—to them, it's all about number crunching, research, valuation and industry analysis. And all of those are important.
But when you get down to it, with money on the line, buying and selling stocks becomes emotional. We've all experienced the range of emotions—not just fear and greed, but euphoria when your stock gaps up on earnings, depression when it gaps down, etc. Moreover, there's the emotional state of the investor, such as overconfidence (after a good run of profits), or feeling like a moron (after a string of losers).
Really, though, it's how you handle those emotions that will go a long way toward determining how much money you make and keep in the stock market. The investors that shoot from the hip and react to every wiggle in the market generally do poorly. Those that have a well thought out plan are usually the ones that excel.
Today, I want to touch on a topic few like to chat about—how to handle losses. Why? First, because most of us have experienced more than a few losses in recent months, whether it's from a 401(k) plan or from individual stocks, and we feel terrible about it. Second, because no matter who you are, and no matter what the market does, you're going to experience some losses on trades in the months and years ahead, and it's vital to think about losses in the right way.
Believe it or not, my personality is a bit at odds with being an aggressive growth investor. In fact, I often think of myself as a "conservative aggressive" investor—for whatever reason, the pain I feel during drawdowns (drops from a portfolio's peak value) is much more intense than the joy I get from having a good month or two. It's just the way I am.
Thus, even though I cut all losses short so they can't cause enormous damage (rule #1 of growth stock investing!), I tend to take losses seriously...possibly too seriously. Because I run a relatively concentrated portfolio (up to 12 stocks in Cabot Market Letter's Model Portfolio), each loss takes a larger chunk of the total portfolio than, say, if I had 20 or 25 stocks.
However, while losses are extra painful for me, I try to think of it this way: The stock I just lost money on is one of thousands of trades I'll make in the years ahead. While seeing some money go up the chute stinks, thinking this way helps me remember that I'm not in the stock market to get rich this month or this year.
I also try to remember that, since I'm using a proven system, I'm putting the odds in my favor...but that doesn't mean the odds will always win out. If I think a trade has a 65% chance of working, that still means I'll lose money 35% of the time. And, realistically, you're probably going to lose money on nearly half your trades, and make money by having your winners outweigh your losers (i.e., your winners will go up an average of, say, 25%, while your losers will fall an average of, say, 10%).
Thus, losses are simply part of the process, and that goes for novices or experienced professionals. The difference is that novices personalize the losses and never learn from them. Professionals realize losses are inevitable in the stock market and learn from them.
I realize this isn't the most joyous topic, but I also know that the past 18 months hasn't been the most joyous of market environments. Thus, if you're still feeling down and out about the past, get in a better mindset—look to learn from your losses, as opposed to being weighed down by them.
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