Cutting losses
One of the most common mistakes new investors make it letting losses get out of hand. There is a saying on Wall Street that you should, ‘Cut your losses. and let your winners run’. This is easier said than done. It is hard to admit that a stock you carefully researched and then bought in cautious thirds has let you down. But it happens. Frequently. The trick is to have a plan.
It always surprises me that there is not more discussion about when to sell a stock. It should be front and center when you buy it. Are you expecting a quick gain or are you holding it for the long term? Is is a volatile stock or a steady, range bound income star? As a general rule, I will sell a stock if it falls 10% or more after I buy it. For stocks I have bought for a quick trade, I will simply put in a stop loss order at 10% below the price I paid. While this loss discipline is helpful, I find it is only applicable in about 40% of the cases. Some stocks I buy, especially if they are well below $100 a share and are volatile, may drop 10% in a few days, only to rebound 15% the following week. Others stocks may drop 10% in an overreaction to an earning report, only to rebound in the same day. A stop loss set at 10% would get me out of the stock but I would lose the rebound gain. Some other stocks pay a dividend of 5% or more, so a 10% drop in the price, is more like a 5% drop. One of the reasons you should not have more than 50 stock positions is that you need to be familiar enough with each position to know what the exit plan is for each one. And attentive enough to act, or not act, on a specific stock’s exit plan. It is helpful to commit yourself to that plan in writing - say on a printed spreadsheet or list clearly visible from the monitor you trade at.
Having a written plan is like making a contract with yourself. Keeping it front and center, visible where you trade, helps you keep to your strategy.
I rarely sell stocks I have bought for their dividend, even when they fall. If the reason for the drop is temporary, say a drop because of a natural disaster or a one-off earnings miss, I may even buy more if the price drops below my average cost per share. I will only sell when the stock’s story changes in a material way, say for example an accounting scandal or corporate or legislative action that undermines their long term viability.
If I have bought a stock for a short term trade, I buy and sell with firm gain/loss percentages. Usually I sell at a 20% after tax gain, or a 10% loss.
Volatile stocks are a judgment call. If the stock is popular, that is frequently mentioned by traders and pundits in the business press, I may hold after a 10% loss if there is still a lot of positive discussion about it. It frequently rebounds. If I find myself with a 20% loss, that baby is gone.
The biggest dilemma for me is when to sell big winners that suddenly go sour. For example, Chipotle when the contamination issues dropped the stock like a rock. I sold, only to watch the stock to rebound, then soar, the following year. I have similar stories with other big name stocks, bad stories drop the stocks like a rock that are later forgotten as the stock moves on to even greater highs. These are what I think of as ‘pain trade’ stocks. Hang on at your own risk. In general though, be aware that a quick sale at a 10% loss may allow you to get back later at a better price if you still think the company’s prospects are good. Just be aware that the wash sale rule means you have to wait 30 business days to get back in if you want to deduct your losses on you taxes. You may miss the rebound by then. Have a plan.
Market Yesterday (missed the midnight cut off): Quiet, up after declines. Not much trading as I am boxed in on my puts due to the steady market decline. Hoping to get out tomorrow if rebound continues.