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If You’re Not Feeling Stupid, You’re Not Managing Risk

July 14, 2014

Sometimes after you sell a stock to cut short a loss, the stock will turn around and move up in price. This has happened to me thousands of times. Do I feel dumb or get angry? No. Investing and trading stocks is a business of playing probabilities so that the profit from winners outweighs the losses over time.


It is completely unrealistic to think you’re going to be right all the time or think that you can hold losses and they will never leave you broke. Making you feel stupid is the market’s way of pressuring you to act foolish. Don’t succumb. Remain disciplined and cut your losses. The alternative to managing risk is not managing risk, and that never turns out well. This concept should be obvious, but in fact it is too often overlooked.


Although it’s certainly not a secret (it’s the most frequently mentioned subject in most books written by successful speculators), it’s difficult to do because it goes against human nature and requires strict discipline and a divorce from one’s ego.


I can’t make you cut your losses any more than I can make you diet and exercise to lose weight; that’s a personal choice. All I can do is share with you what I know from my own success and tell you that the stock market is no place for someone who is easily discouraged by mistakes. Mistakes are lessons, in other words, opportunities to improve. These experiences are the greatest part of the learning process.


Although cutting your losses won’t guarantee that you will win in the stock market, it will help ensure your survival.



Why Most Investors Fail to Cut Their Losses


Investors usually become emotionally attached to their stock holdings. They may put in many hours of careful research building a case for a company, scouring financial reports, and maybe even trying the company’s products. Then, when their proud pick takes a dive, they can’t believe it. They make excuses for the stock’s decline; they call their broker and search the Internet looking for favorable opinions to back up their faith in the company. They ignore the only opinion that counts: the verdict of the market.


As the stock keeps sliding, their losses mount. Usually, what happens is that the stock’s decline becomes so huge and unbearable that they finally throw in the towel and feel completely demoralized. Don’t allow yourself to get caught in this lethal trap.

To have lasting success in the stock market, you must decide once and for all that it’s more important to make money than to be right. Your ego must take a backseat. Sounds like a simple decision to make, but think again. Many people speculate in stocks without getting this one straight. Their self-image rides on the success or failure of their trades. As a result, they make excuses for obvious losers rather than admit mistakes.


Ultimately, the success of cutting losses rests on your ability to remove emotion—hope, fear, pride, excitement, and the like—from your investment decisions, at least to the point where it doesn’t override good judgment.


Most investors fall into psychological traps. Feelings of hope and greed confuse their decisions to sell their stock holdings at a loss or, for that matter, at a profit. They find it difficult to sell, and so they rationalize a losing position. They convince themselves that they haven’t taken the loss until they sell it.


Losses are a part of trading and investing; if you are not prepared to deal with them, then prepare to eventually lose a lot of money. In trading and in life, how you deal with losing is the difference between mediocrity and greatness. Individual stocks are not like mutual funds, they don’t have a manager and they don’t manage themselves; you’re the manager. When investing in stocks, everything is not necessarily going to be “OK” if you just hang in there and wait it out.


For a speculator, small losses are simply the cost of doing business, just as marked-down merchandise is to a retail store operator. A good retail merchant doesn’t hang on to dead merchandise, hoping a particular style or product will come back in vogue a year later. If he’s smart, he marks it down, gets it off the shelf as quickly as possible, and then looks to restock the shelves with something that everyone wants to buy.


Excerpt from Trade Like A Stock Market Wizard by Mark Minervini (McGraw Hill Publishing –2012)

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