There is a feeling, when you’ve made an investment and its working, that you are investing with the “market’s” money, or profit. You start to feel good, confident, you make better decisions, and think less emotionally.
The trouble is, the exact opposite seems to occur when you start to lose.
The initial thought, “it will bounce back”, is replaced with “overall i’m up”, to — sometimes, lets average down (buy more at a lower price).
The mental games we play with ourselves when losing can be extreme. We would generally be happier selling a winner (taking profit) than we would cutting a loser? Why?….it doesnt make sense.
Well, perhaps it does. Perhaps cutting a loser, means ‘taking’ the loss. Perhaps it means admitting defeat. Perhaps its being wrong….
Every great investor talks about the need to cut losers. Every great risk manager talks about position sizing.
There are a number of reasons for this. When we start to lose money, we start to hope….which isnt a strategy. When what we should really do, is focus on making our winners better.
The emotional release of cutting a loser is tremendous, is frees up your mental capacity to lucidly focus on the winning ideas. For us sadists, we can still check the losing names performance after exit….but being wrong and managing that is the first step in become a better investor.
Be honest with yourself. Do you understand why the company is falling? How much can you afford to lose on this investment idea?
Establish a framework, establish a process because it will save you money and time in the long run. Agreeing to sell a stock down 20% and sticking to it, is much easier than trying to work out whether today you should sell or not, as more often than not down 20% becomes down 35%. This process will also help you to size your positions and help with legging in.
