How to Deal with an Investment Loss

FREAK OUT.

^ That’s what most people do when their investments go nuts.

LOOK FOR A REASON.

^ That’s the second thing most people do when their investments go into the toilet.

Neither is helpful.

Why Our Investments Sometimes Go Into the Toilet

1. We don’t always know.
2. It does not really matter.

I’ve had a few investments end up right here, in the toilet.

What We Should Do When Our Investments Go Into the Toilet

This is a way more important question.

Let’s say you bought Amazon stock last week. Great company, lots of revenue, lots of customers, you can get a roll of toilet paper and a wifi router in less than 60 minutes, etc.

So you like the company. You buy 50 shares.

This week, Amazon goes into the toilet.

Then the toilet flushes.

You’re like: “Oh, Crap.”

You have two choices:

1. Close your losing position. This is called “cutting your loss,” and most “trading experts” will tell you to do this.

OR

2. Keep your losing position open. This is called “rolling over your position,” and it means you are going to hold onto a losing investment. Most “trading experts” will tell you this is insane.

Let’s talk about each option.

Cut Your Losses Quickly

Close your damn trade. Walk away. It’s over. You live to fight another day.

If you do this:

1. You will immediately feel a sense of relief.
2. You will probably miss out on the eventual move (if you were right about your original idea) because it is very hard to re-enter a trade once you’ve closed it for a loss.
3. You will protect your investment capital.

Warren Buffett is famous for saying that the first rule of investing is to not lose money. Paradoxically he is famous for choosing investments and then holding onto them forever, even if they lose money.

So which is it?

Trying to learn investing by reading about Warren Buffett is kind of like trying to become Jesus by reading the Bible.

You might learn what the Son of God did, but good luck turning water into wine. In other words: stop trying to be Warren Buffett and just be yourself.

In fact, many investors and traders who try to “obey the rule to cut losses short” end up tired, frustrated, and very poor. They keep taking small losses. It’s death by a thousand paper cuts.

Let’s talk about the second choice.

Hold Your Losses (Maybe Forever)

If you do this, you are making a bet that you made the right bet.

You are deciding to commit to a decision. No matter how long it takes.

If you do this:

1. You are going to feel some psychological pressure. Ok, you are going to feel a HELL OF A LOT of psychological pressure.
2. Everyone has a plan until they get punched in the mouth (said Mike Tyson). In other words, you need to be ready for a day when you exclaim, “I know my plan was to hold my position but this is killing me,” and then you close it for a bigger loss. And then it turns around and goes in your favor and you feel like shooting yourself in the face.
3. You are going to get another chance to enter the same investment at an even better price. If you like Amazon at $650, you’re going to love it at $600.

Some experts will tell you that it’s dumb to hold a loser.

That it’s insane.

That adding to losers, or “cost-averaging,” is insane.

But if you take very few trades, and you choose them wisely, and you plan to hold on for the long term, it does not make sense to jump in and out of the market just because you are temporarily feeling pain.

And the dirty little secret of investing is that it doesn’t matter which one of the above methods you choose. Let me explain why.

It’s all about a Miracle. And the Story of the Rock.

The Story of the Rock

Imagine that someone hands you a giant rock. It’s 200 pounds heavy and you can barely hold it. They tell you that they will pay you $50,000 if you will hold it for them. You are not allowed to drop the rock.

They walk away.

You drop the rock (unless you ARE “The Rock”, haha) somewhere between minute zero and minute five.

You quickly pick it back up. You want to be holding it when they return.

You drop it.

You pick it back up.

This happens over and over. Eventually they return and you get $50,000. You spend half of it on arm surgery.

Now …

Imagine that a woman hands you a pebble. She says,

“This pebble is small but it is precious. Please hold it for me. I do not know if I will return tomorrow, or the next day, or in ten years. Please hold it for me, even in your pocket is fine, and I may return and ask you to hold another. And another. But at most just a few pebbles.”

Then she offers you $50,000 to hold the pebble.

She returns 5 times and hands you more pebbles. Then one day she returns to collect the pebbles, pay her debt to you, and leaves.

The only difference between these stories is the size of the rock.

And the size of this rock is the Miracle.

The Miracle of Small Trade Sizes

It might seem like a stretch to use the word “Miracle.”

It’s not a stretch.

Here is the Miracle of Small Trade Sizes: If you reduce the size of your average trade, it won’t matter if you cut your loss quickly or hold the trade forever.

If you reduce your trade size to the point where it is just a pebble (compared to the size of your total investment capital), here is what happens:

1. You immediately feel better about every investment.
2. You will never get rich off one big score.
3. You will never worry about a loss.
4. You will be able to add to your investment if it moves in your favor. This can increase the size of your win, so when you make a good investment decision it might actually turn into a nice return.
5. You will sleep more peacefully.
6. You will cut some losses short, you may ride other losses and roll them over (that’s when you add a little pebble to your existing open investment position).
7. You will, for the first time in your investing career, make more money more easily than ever before.

In fact:

The fastest and surest way to immediately improve your investing is to reduce your average trade size.

That’s the Miracle.

Happy trading,

Rob