Nobody likes to be wrong. And it’s that sentiment that causes many investors to lose their shirt — taking a loss is proving exactly that… that you’re wrong. It’s been proven that investors tend to sell their winners too early, satisfying their desire to be right, and hold on to their losers too long, hoping that they will not have to take a loss and be wrong.
The simple fact is that we as investors will be wrong from time to time. But it’s whether you admit your mistake and move on that will determine whether you’re an average investor (generating only 2% per year) or an extraordinary investor. Or as investing legend George Soros once said, “It’s not about being right or wrong, rather, it’s about how much money you make when you’re right and how much you don’t lose when you’re wrong.”
Investors have a hard time controlling their emotions, which often leads to small losses turning into large ones. When a holding is down 25%, most investors tell themselves either that A) they’re not going to take any action because they’re in it for the long haul, or B) they’ll sell once the price gets back to break-even. What usually ends up happening is that they become “buy-and-fold” investors, or they continue to hold a losing stock for years, hoping for the day it gets back to even.
But hope isn’t an investment strategy… at least not a good one.
Having an escape plan before you purchase your next investment will help take much of the emotion out of investing, and will go a long way toward preserving your capital. It doesn’t much matter if that plan involves a trailing stop-loss that rises in step with a rising share price, or a hard stop at a specific price point — either strategy will cut your losses and help you sleep better at night.
In my premium newsletter Maximum Profit, our sell signal is clear: when a stock’s relative strength (RS) rating drops below 70, or if we hit a trailing 30% stop-loss, we sell. No questions asked. Case closed.
Could we still incur the occasional large loss? Yes, but rarely.
In fact, since this newsletter’s inception in June 2013, we’ve only had two losses greater than 20% in the main portfolio: A 21% loss on Barrick Gold Corp (USA) (ABX) last October and a 29% loss on Newmont Mining Corp (NEM) in July 2015– two stocks in the commodities sector known for their violent swings.
Overall, in the last three years the average loss in my main portfolio is only 7.9%. That’s less than half the average gain of 18% during the same period.
This is due to my system’s innate ability to get us out of a stock before it collapses. Take our most recent closed position as a prime example. In October 2016, the Maximum Profit system tagged casino operator MGM Resorts International (MGM) as a solid buy. We held the stock for four months before my system indicated it was time to sell. We made nearly 9% on the trade in that time span (27% on an annualized basis).
But more important, we got out before the stock dropped 10% in the ensuing days.
And neither is this a one-time event. The system has saved us from numerous disasters…
Seadrill Ltd (SDRL) is probably one of the best examples. In September 2013, we caught the tail end of the uptrend in the oil and gas exploration firm. We held the stock for only 28 days before the system told us to exit the trade with a 1% gain.
Since then, the shares are down 95%, all but wiping out “buy-and-hold” investors, or those using the “hope” strategy — hoping they would get back to even before selling.
More than three years later those folks are still “hoping” for a turnaround.
American Railcar Industries, Inc. (ARII) is another example. After booking a 62% gain in about a year, the stock fell nearly 50% over the next 10 months… and is still down 34% from when we sold at the end of November 2014.
My point is that it’s critical to have a system in place to help protect you from losses. Remember these three rules:
Investment Rule No. 1: Let Winners Run — you can trim winning positions to “take money off the table” or bring them back to their original portfolio weights, but don’t cut a winner short just to prove to yourself that you were right.
Investment Rule No. 2: Cut Losers Short — sell positions that simply aren’t working. If the investment isn’t working in a rising market, it likely won’t work in a declining market.
Investment Rule No. 3: Keep Your Emotions In Check — don’t get swept up in the short-term movements of the market, or allow the media and Wall Street to bully you into buying or selling your investments. Think for yourself.
If you’re think you’re relying on “buy and hold,” then chances are good you may be relying on “buy and hope” instead. That’s not to say buy and hold doesn’t work — it does — but all too often we as investors get in our own way. Take stock of how you’re conducting your own investing decisions. You may find that you could stand to make some changes.
If that’s the case, then consider making things easier on yourself and using a proven system that eliminates many of these common problems. By using rigorously tested methods, the Maximum Profit system issues clear and direct “buy” and “sell” signals. Not every pick will pan out — no system is perfect — but if history is any guide, you’ll limit losses while still enjoying fantastic gains in the process. To learn more, go here.
StreetAuthority’s mission is to help individual investors earn above-average profits by providing a source of independent, unbiased — and most of all, profitable — investing ideas. Unlike traditional publishers, StreetAuthority doesn’t simply regurgitate the latest stock market news. Instead, we provide in-depth research, plus specific investment ideas and immediate action to take based on the latest market events. Visit us at StreetAuthority.com.