How many times do we enter a highway to get to a destination without (us or the GPS) knowing anything about where/when to exit the highway? We rarely join the highway just for a ride!
In contrast, when many of us (retail investors) do financial investing/trading, we are quick to act on a hot tip, either from intuition, or something someone whispered in your ear, or from a financial news network, ... The action from the hot tip is usually to buy a specific financial instrument (typically, a stock or ETF or mutual fund) - more generally, to apply cash to "enter" a trade or a position.
Upon entry, attachment and hope sets in - "This stock has to go up." "I am fond of this stock." "I got it at such a low price." "My stock has excellent fundamentals." "I am in it for the long haul." Little does the stock know of your hopes and dreams about the stock! It continues on its merry journey of ups and downs, well-explained after-the-fact by all the financial pundits. The result of this phenomenon is that we hold on to the stock in our portfolio, with no clear objective - metaphorically, we continue to ride on the highway with no view of the destination or the exit!
If the stock does go up, there come other factors that induce inaction - "It has gone up so much, it will go up more." "I will incur capital gains taxes if I sell now and realize the profit." "I will consider selling when I am in a lower tax bracket, or I have other capital losses to compensate." "This stock pays good dividend." The stock is still oblivious to our motivation to hold the stock!
Lo and behold, the stock encounters potholes on its journey - Citigroup dropping to 5% of its value over 2007-2008, and recovering to only 15% of its peak value over 2008-2018; and, more recently, GE losing over half the value from its recent highs. Ouch! I dare not mention any names from the dot-com-bubble-burst from the early days of this millennium, or the deeper scars from dollar-cost-average buying more and more of the falling knife!
The lesson from this experience should now be obvious: Have an exit strategy before you decide to enter, and the strategy should include booking profits as well as cutting losses in a finite timeframe.
..and for those of us who find it difficult to define exit strategies on stocks, ETFs, mutual funds ...options offer a forced price and timeframe - the strike price and expiration date - with definite profit/loss consequences.
Stay tuned for more ...
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