- Before investing in a stock, it’s crucial to have a plan for managing losing positions
- But before you do that, it is critical to examine the reasons behind your decision
- Ultimately, there is no one-size-fits-all answer to managing losing positions
Investors often ask me how they should handle stocks that have experienced long-term declines that have lasted for weeks, months, or even years.
The fundamental question on their minds is how to manage losing positions.
Well, the answer is simple:
It Depends!
There’s no one-size-fits-all answer because every stock and every investor is unique. However, all strategies should have a common starting point: the initial investment.
The inability to manage declining positions often stems from a fundamental mistake made at the outset. Investors are often unable to explain why they bought a stock.
The answers are often flawed.
- “I work at this company.”
- “My cousin/uncle/friend just invested in it.”
- “They said it on TV/newspapers/site.”
- “It has gone down a lot, it will go back up.”
- “It’s gone up a lot, it’s going to keep going up for sure.”
- “Everybody is investing in it.”
These justifications don’t hold up, and when things take a turn for the worse, it’s easy to feel lost.
How Should You Manage Losing Positions?
The approach varies depending on whether you’re focused on the short-term (like a trader) or the long-term (like an investor).
If you’re operating in the short term, one of the most sensible steps is to set a stop-loss. The old trading adage, “Cut losses and let profits run,” still holds true.
Another option is fractional entries, which is quite distinct from randomly averaging down at a loss. Fractional entries involve determining your strategy in advance: how much capital to invest, how many entries, and at what levels or under what conditions.
If the stock continues to fall, you simply follow your predetermined strategy.
Consider selling at a loss to offset losses. Losses are part of any strategy and cannot be avoided. By planning how to use losses within your overall portfolio, you can recover them from gains in other stocks, taking advantage of tax benefits.
Lastly, consider the behavioral aspect, which is often overlooked but critical. Would a 20%, 30%, or even 50% drop in stock value cause you to panic, or can you remain calm?
Remember, some of the best opportunities arise during bear markets. If you understand a stock, buying it at a discount can be a great choice.
As emphasized earlier, planning and understanding the valid reasons for investing in a particular stock are crucial. Random investing is not a strategy.
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Disclaimer: This article is for information purposes only; it is not intended to encourage the purchase of assets in any way, and does not constitute a solicitation, offer, recommendation, opinion, advice or investment recommendation. We remind you that all assets are considered from different angles and are extremely risky, so that the investment decision and the associated risk are specific to the investor.