Are You Stuck in Bad Stocks? Try This Simple Trick
Emotional investment often pushes us to deny reality. But there is a key to looking at a stock in an objective manner.
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One of the most common mistakes that investors make is with losing stocks. They fail to cut these bad stocks, become frozen, and let losses grow too large.
As the emotional and financial investment in the stock increases over time, it becomes extremely difficult to take action. Inertia sets in, and there is a tendency to believe that it is too late to take action. We don't want to admit the mistake and end up doing nothing.
Quite often, this sort of situation will lead to data mining. We keep looking for reasons to continue to hold on to the position and try to justify the inaction. We tell ourselves that the stock still has promise and convince ourselves that it will eventually work out. Our emotional investment pushes us to deny the reality of the situation.
So what do you do?
The first step is to forget your entry point. Forget the fact that you are sitting on a big loss. Start the day as if you just bought the stock that morning, and you have no loss or gain.
The next step is to develop a plan to manage the trade. You have a new cost basis, and that is the only thing that will matter.
The problem started because you failed to manage the position effectively. You failed to cut it when you should have, or maybe you were just a victim of surprise news, poor market conditions, or bad luck. It doesn't matter. Those things are all irrelevant starting this morning.
You are going to have a new plan for managing the stock, and it will ensure that you will not let the loss grow beyond a certain point. You will manage the stock like it is a brand new position and you just bought it. You will stay disciplined and handle it in the now.
Technically, this approach is called mark-to-market. Our original entry point is irrelevant, and your new cost basis is the market price starting that day.
Forgetting what you paid for a stock isn't an easy task, but it is the key to looking at a stock in an objective manner. If you have been holding a stock for a while and are sitting on a fairly sizable loss, your emotional reaction is going to overwhelm your objectivity. You have to consciously suppress those feelings and stay very analytical in your analysis.
As a practical matter, the price you pay for a stock really is irrelevant. You can't go back and change that price, so there is no value in dwelling on it. What we can do is make decisions today, and we will make better ones if you aren't saddled with emotions.
It is easy to understand why we are hesitant to deal with a stock that we have been holding for a while. We don't even want to look at it as it just reminds us of our mistakes.
Inertia in decision-making is probably what hurts investors and traders more than anything else. It is imperative to force yourself to make decisions about your stocks on a regular basis, and you do that by marking to mark and looking at the situation with fresh eyes. Most of the time, doing nothing is the right choice, but you have to make that decision consciously rather than let it happen by default.
Good investing and trading require patience, but that doesn't mean inertia and inaction. Mark your stocks to the current price, forget your entry points, and then force yourself to make decisions about whether to buy, sell, or hold. Removing emotions from your decision-making isn't easy, but it is in your power to do so if you choose.
At the time of publication, Rev Shark had no positions in any securities mentioned.
