No one picks winning stocks every single time. At some point, you will have a loss. Knowing how to deal with stock market losses will make the difference between a small loss that will let you quickly get back in the game, and a devastating loss that can damage your portfolio and your confidence.
One of the reasons I love the stock market (though sometimes it’s more of a love-hate relationship) is that it’s such a battle of the mind. Of course, few pundits or analysts will tell you that—to them, it’s all about number crunching, research, valuation and industry analysis. And all of those are important.
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But when you get down to it, with money on the line, buying and selling stocks becomes emotional. We’ve all experienced the range of emotions—not just fear and greed, but euphoria when your stock gaps up on earnings, depression when it gaps down, etc. Moreover, there’s the emotional state of the investor, such as overconfidence (after a good run of profits), or feeling like a moron (after a string of losers).
Really, though, it’s how you handle those emotions that will go a long way toward determining how much money you make and keep in the stock market. The investors that shoot from the hip and react to every wiggle in the market generally do poorly. Those that have a well thought out plan are usually the ones that excel.
It is particularly important to know how to handle losses. Anyone who has been in the market for any length of time will have experienced more than a few losses. They may be in a 401(k) plan or in individual stocks, but either way, we feel terrible about it. But no matter who you are, and no matter what the market does, you’re going to experience some losses on trades in the months and years ahead, and it’s vital to think about them in the right way.
Believe it or not, my personality is a bit at odds with being an aggressive growth investor. In fact, I often think of myself as a “conservative aggressive” investor—for whatever reason, the pain I feel during drawdowns (drops from a portfolio’s peak value) is much more intense than the joy I get from having a good month or two. It’s just the way I am.
Thus, even though I cut all stock market losses short so they can’t cause enormous damage (rule #1 of investing in growth stocks!), I tend to take losses seriously...possibly too seriously. Because I run a relatively concentrated portfolio (up to 12 stocks in Cabot Growth Investor‘s Model Portfolio), each loss takes a larger chunk of the total portfolio than, say, if I had 20 or 25 stocks.
However, while stock losses are extra painful for me, I try to think of it this way: The stock I just lost money on is one of thousands of trades I’ll make in the years ahead. While seeing some money go up the chute stinks, thinking this way helps me remember that I’m not in the stock market to get rich this month or this year.
I also try to remember that, since I’m using a proven system, I’m putting the odds in my favor ... but that doesn’t mean the odds will always win out. If I think a trade has a 65% chance of working, that still means I’ll lose money 35% of the time. And, realistically, you’re probably going to lose money on nearly half your trades, and make money by having your winners outweigh your losers (i.e., your winners will go up an average of, say, 25%, while your losers will fall an average of, say, 10%).
Stock market losses are simply part of the process, and that goes for novices or experienced professionals. The difference is that novices personalize the losses and never learn from them. Professionals realize losses are inevitable in the stock market and learn from them. Thus, if you’re feeling down and out about your stock losses, get in a better mindset—learn how to deal with stock market losses, as opposed to being weighed down by them.
