Every investor picks a bad stock at some point…
In fact, it probably happens more often than you want to admit.
Even the world’s best investors do it from time to time… Just ask Warren Buffett.
In reality, though, we would all love to find investing success like Buffett. And one of the biggest differences between investors like him and average Joes comes down to a simple question…
How do you know when it’s time to limit your losses?
That’s a foundational question… It’s something that every successful investor should ask themselves before putting their hard-earned money to work.
And in the midst of the recent sell-off, it’s more pressing than ever…
The stock market is off to a rough start in 2022.
The S&P 500 Index turned lower after hitting a new all-time high on the first trading day of the year… It’s down roughly 9% over the past few weeks. Some of the other major indexes have suffered worse.
Whenever the market starts falling like this, many investors find themselves in a hole. The losses start to pile up… And these folks begin to panic.
If you’re one of these investors today – or if you just want to know how to get out of trouble the next time – I’m here to tell you…
Stop digging.
Now, that sounds easier than it is…
The problem is what psychologists call “confirmation bias.” It’s a fancy term that explains how people tend to look for facts or evidence that confirm what they already believe.
Even when we find information that conflicts with our original investment thesis on a stock, our brain only looks for the other side – the “good” data that supports it. And this confirmation bias can start an expensive lesson in stock-position management.
Some investors think they can overcome confirmation bias. They plan to just reevaluate their positions as the market ebbs and flows. But there’s a big problem…
As humans, we’re often too emotional for our own good. Even the best investors can ride a stock to near zero.
We’ve seen countless examples over the years, like the tech wreck in 2000 and 2001… the financial crisis and bear market of 2008 and 2009… and now, maybe it’s happening with “stay at home” stocks like Peloton Interactive (PTON), which I wrote about yesterday.
The pain of walking away is often too difficult… That’s especially true when your emotions tell you that your once-prized stocks are “just another day away from a turnaround.”
If you’re in a hole today, it’s time to stop digging. Here’s how…
The world’s best traders use programmatic signals that tell them when to walk away. Personally, I use the Power Gauge…
When the Power Gauge turns “bearish” on any of my stocks, I know it’s time to move on. But even without this system, you can still limit your downside with a basic strategy…
Use a trailing stop.
A trailing stop limits your losses in a single position to a preset amount. It imposes a discipline in your portfolio that helps you eliminate confirmation bias from the moment you invest. And it can save you money even when you’re just plain wrong.
It’s easy to execute, too…
Let’s say you buy a stock at $100 per share. You can set your initial stop loss at $80 per share… So your maximum loss would be $20 per share (or 20% of your position).
The “trailing” part is that your stop moves up with – or trails – the stock as it moves up.
So if the stock runs up to $125 per share, your 20% trailing stop would rise to $100 per share. In this example, your stop would always be 20% below the highest price for the stock… But it would never be less than the original $80 per share.
Using a trailing stop imposes discipline in your portfolio management that your brain can’t get in the way of… It takes your emotions out of the decision-making process.
In other words, it makes you stop digging when you’re in a hole… And that will save you a lot of pain – and money.
With the market selling off so far in 2022, this idea is as important as ever.
Good investing,
Carlton Neel
