The Psychology of when to “Cave”

I bet I hate to lose just as much as you do. Psychologists say that we tend to focus on small failure rather than the investing successes we have. It’s true, and I made a few mistakes last year. They were not catastrophic, and I seem to have been able to roll with it… but I still go back and look at those stocks and want to kick my self.

I’m a fairly optimistic person, so I have to be careful not to become over confident in my stock picks. Remember, the Price of a stock does not care how we feel on any particular day. We may feel supper confident it will go up, and it still goes down. Why? Because we did not know enough about the stock, and went with our gut rather than information. Sometimes even with good information that indicates a specific stock will go up, other market forces cause it to go down. Case in point, last Wed. Xilinx (XLNX) announced it’s best quarter ever. Thursday is went up about a $1.30, and then Friday the market took it all back because it was freaking out about if Timothy Geithner will get reconfirmed or not… some times all your good “feelings” get wiped out for some seemingly unrelated reason.

I tend to sell a winner too quickly and hang on to a loser too long. One of my goals this year is to use a better trading tool. I’m currently just using the standard Schwab account. I can put in Stops, or limits, but not both. I have downloaded StreeSmart, which will let me set trailing stops. On paper I always figure out what my upside exit is as well as my down side exit is. This way, I can take the emotion out of the equation. Lately I have been following the advice to always sell if I’m down 10%. If I don’t know enough about why a stock is going down, assuming I had done my home work to buy in the first place, then I tend to sell before it’s down 10%. If the stock drops 10%, I’m out… Some times I don’t, but if I don’t, it’s because I’m continuing to buy some more… but I’m working on getting the emotion out of any trades I do.

For every trade you do, make sure you know why you are doing it. Before you trade, write down every thing you know about an investment. Then write down what you think you don’t know. Then, and only then are you ready to make a trade. Then if it goes down, you can look at the reasons you bought in the first place. If all the reasons are still valid, then it may still be Ok to keep it… Otherwise it’s time to cut it loose.

If an investment does not perform, and just goes sideways, then you should also think about letting it go as well. You need to realize there is an opportunity cost for any investment. If you come across a better investment, you should take a look at what you have that has not appreciated, or is down. Many times by selling and re-investing in something better will in the long run be more profitable.