Selling Stocks Short; October 28, 2007

Selling-Stocks-Short; October 28, 2007

Last time out, I talked about getting out of a position too early. Today I want to take look at hanging onto losing positions. In my opinion, this is the cardinal sin of investing.

When I was an investment advisor, people who held onto losing positions were the bane of my existence. If I had a dollar for every time that a client said that they couldn’t sell a position because it was at a loss, I’d be on easy street. We called these people the “be backs”. They weren’t going to close out the position until it “be-back” to the price the trade was initiated.

BUY and HOPE is not an investment strategy. Neither is SELL and PRAY.

During the market collapse a few years ago, I was amazed at how many people never got out. I don’t know what kind of kool-aid they were drinking, but it was near fatal.

I had one client (in his 60s) who was up to his eyeballs in tech stocks. He and his “other” broker knew more than I did and thought tech was the place to be. Against my advice, he allocated about 90% of his portfolio to tech. At the top, his portfolio was about $750,000. At the bottom, it was worth less than $20,000. He bought Lucent above $70 and rode it to $4.

He didn’t want to hear about stops, money management or about position sizing. He rolled the dice and they came back “snake-eyes”. He turned an ill-advised trade into a life changing experience. I don’t know what he’s doing today, but he’s not retired.

When you make a trade, it’s a business decision that’s made objectively and without emotion.

I can guarantee you this – losses can and do occur. It’s an inescapable fact. Things happen every day that we don’t expect or can’t control. Successful investors have a plan for addressing the unexpected and it’s in writing.

Here’s how I manage a losing trade.

• When I place a trade, the first thing I do is to determine the maximum amount of risk that I’ll assume on the trade. This is my worst case scenario.
• The most risk I’ll take any each trade is 1% of my account value. This is where I place my stop.
• I make the decision when to close out a losing trade BEFORE I make the trade. Doing so, takes away any subjectivity and emotions. This is important because when crap hits the fan, the last thing I want to do is start making decisions when my emotions are “out of whack”. Decisions made during the “heat of battle” make for great cocktail party chatter, but in reality are bad for the bottom line.
• When I place a trade, I also place a Good til Cancelled stop loss order. I do this so that I don’t have to live in front of my trading screen.
• Sometimes a Good til Cancelled order isn’t possible. If it isn’t, I’ll use put and call options as an alternative. The cash outlay is small compared to the potential loss.
  

The last point that I want to make concerns your investment capital. If you lose it, it’s gone. You can’t be in the game if you’ve lost your money. This is paramount. You have to guard your money as if your life depends on it because in the end - it does.

That’s it for inning number eight – one more to go. That’s about it for now.

RAC
The Stock Trading Advisor