Taking losses is a tough and bitter pill to swallow on Wall Street and other trading places and no one is immune to making mistakes and being wrong about a trading decision. But the big mistake many make isn't in taking a loss, but rather not taking a loss and letting a loser continue to erode the equity in a trading account or portfolio.
Losers not dealt with are like a cancer. And just like a cancer can quickly spread throughout the body, a loser can quickly spread throughout your portfolio if left untreated.
Falling stock prices are sometimes hard to swallow. But for long-term investors there?s no need to be concerned!
No one likes to see the markets drop. It?s not a pretty sight unless you?ve invested in put options! So many investors have a hard time dealing with and accepting falling stock prices - but for the wrong reasons.
True courage comes when you watch your investment take a twenty percent dive in one afternoon. Anyone who has been through a bear market knows that it takes enormous discipline to stick to your guns while everyone else pushes the panik button.
Influenced and plagued by images of depression, recession and corporate layoffs, the manic stock markets becomes a breeding ground for chaos and faulty logic. Perfectly good, strong and healthy companies begin selling for fractions of their true value, disregarding all fundamentals in the long-term economics of the business.
So here are three fundamental truths that will help you deal with short-term market losses:
Truth One: You Own a Business, Not a Stock!
By owning a stock you are holding a piece, or share, of a business in your portfoilio. In order to be a successful investor you must do two things:
1. Remove all emotions from each of your financial decisions especially the emotions of Fear and Greed. I wrote about that yesterday in ?Trading Psychology?. Letting your heart and emotions interfere with your actions is foolish in most cases, fatal in economic ones.
2. Separate the underlying business from the stock price! They are not the same thing. Even a great company is a lousy investment if you pay too much for it.
3. Don?t get attached to a loser.
Many investors hold on to losing positions way too long. They don?t like selling at a loss because this would mean owning up to the fact that their investment decision was a mistake. And who likes making mistakes?
But this is one of the most important lessons investors have to learn: It?s only worth while holding on to securities - that have dropped - which are of high quality and where the chance of a turn around is more likely than not!
Truth Two: If you are a Long-Term Investor, Falling Prices can be like Christmas Gifts
The only time a bear market could be bad for you is when you need the money that you?ve invested. For that reason you should never invest money that you will need immediately at some point in time!
But if you are investing with a time frame of ten or more years, falling prices represent only one thing: the opportunity to buy more of of favourite company at a lower price. By doing this you are averaging the purchasing cost of your stock meaning that you are lowering the average purchasing price. This will enable you to be back in the green much earlier than before.
Example:
You purchased a stock for $100. It now falls down to $50 at which point you repurchase. Your average costs have now been reduced to $75 ( $100 + $50 : 2 = $75 ) meaning that you don?t have to wait anymore until your stock goes back up to $100 to be in the green again, but ?only? $75.
Truth Three: It doesn't matter.
If you have a well diversified portfolio with strong growth companies, it doesn?t really matter if 2 or 3 stocks don?t perform well because the bottom line is that even in the best portfolios you can, and more often than not, will have the one or other stock that doesn?t perform well.
This is perfectly normal because the performance of stocks depend on so many factors.
The slightest rumour or threat of war, rising oil prices or interest rate hikes for instance, can detonate a reaction on world markets which then react speedy and unpredictable.
So don?t worry too much if the one or other stock in your portfolio is down. As long as the rest are performing well?big deal! You should still be in the green!
And as investors we must always bear one thing in mind! Just like there are many opportunities of making nice gains, there is always risk of losses in any trading and investing no matter in what way, shape or form!
That?s why you should only invest money that you don?t really need and where losses don?t mean the end of the world for you having you live on a shoestring.
And: Never borrow money to invest! This can backfire very quickly with you sitting on a load af debt. The stock market is not a gambling place! That?s what casinos are for!
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