In my continuing series on exposing bad practices of retail investors, this one addresses how one may deal with losses.
Looking at a famished position (say, an instrument bought at a high price, and whose value has significantly dropped) with high anticipation is an undesirable, but commonly practiced choice. Can this pain be alleviated?
An alternative is to sell the position, use the loss howsoever given your income-tax situation, collect the cash and put it to good use - hopefully, in an instrument other than the one that caused the damage and the pain! Psychologically, this allows the investor to "move on," and can help the investor to overcome and eventually forget the pain and the hurt ego associated with booking the loss.
A better alternative is to place a stop loss, good-until-canceled order on every position held. (Another, somewhat complex strategy with its respective pros and cons - discussed in a subsequent article - is to buy insurance with a protective put option) If the stock in your portfolio starts moving in the wrong direction, and to an extent that exceeds the normal flutter (engineers will recognize this as the noise vs the signal), the live order will trigger and sell the stock. It will mind the store unemotionally, and frees you up for subsequent actions with the generated cash.
There are some very rare situations when this approach can hurt - for example, the momentary selling panic that happened for a few minutes in May 2010 (link to New York Times article), when the protective put would have been a better approach.
Also, we need to remember that the market is open and actionable (even for open stop loss orders) only about 19% of the time - allowing for the time every day between market close and market open, weekends, some half-days, and other off days. How can one mind the store while the "market is sleeping?" That, for another time!
Looking at a famished position (say, an instrument bought at a high price, and whose value has significantly dropped) with high anticipation is an undesirable, but commonly practiced choice. Can this pain be alleviated?
An alternative is to sell the position, use the loss howsoever given your income-tax situation, collect the cash and put it to good use - hopefully, in an instrument other than the one that caused the damage and the pain! Psychologically, this allows the investor to "move on," and can help the investor to overcome and eventually forget the pain and the hurt ego associated with booking the loss.
A better alternative is to place a stop loss, good-until-canceled order on every position held. (Another, somewhat complex strategy with its respective pros and cons - discussed in a subsequent article - is to buy insurance with a protective put option) If the stock in your portfolio starts moving in the wrong direction, and to an extent that exceeds the normal flutter (engineers will recognize this as the noise vs the signal), the live order will trigger and sell the stock. It will mind the store unemotionally, and frees you up for subsequent actions with the generated cash.
There are some very rare situations when this approach can hurt - for example, the momentary selling panic that happened for a few minutes in May 2010 (link to New York Times article), when the protective put would have been a better approach.
Also, we need to remember that the market is open and actionable (even for open stop loss orders) only about 19% of the time - allowing for the time every day between market close and market open, weekends, some half-days, and other off days. How can one mind the store while the "market is sleeping?" That, for another time!
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