Saturday, August 6, 2016

The Art Of Cutting Your Losses




One of the most enduring sayings on Wall Street is "Cut your losses short and let your winners run." Sage advice, but many investors still appear to do the opposite, selling stocks after a small gain only to watch them head higher, or holding a stock with a small loss, only to see it worsen.No one will deliberately buy a stock they believe will go down in price and be worth less than what they paid for it. However, buying stocks that drop in value is inherent to the nature of investing. The objective, therefore, is not to avoid losses, but to minimize the losses. Realizing a capital loss before it gets out of hand separates successful investors from the rest. In this article, we'll help you stand out from the crowd and show you how to identify when you should make your move.
 Reasons Investors Hold Stocks With Large Unrealized Losses

In spite of the logic for cutting losses short, many small investors are still left holding the proverbial bag. They inevitably end up with a number of stock positions with large unrealized capital losses. At best, it's "dead" money; at worst, it drops further in value and never recovers. Typically, investors believe that the reason they have so many large, unrealized losses is because they bought the stock at the wrong time or it was a matter of bad luck. Rarely do they believe it is because of their own behavioral biases.
Let's look at a few of these biases:
  • Stocks Always Bounce Back - Don't They?
    A glance at a long-term chart of any major stock index will see a line that moves from the lower-left corner to the upper right. The stock market, over any long time period, will always make new highs. Knowing that the stock market will go higher, investors mistakenly assume that their stocks will eventually bounce back. However, a stock index is made up of successful companies. It is an index of winners. Those less successful stocks may have been part of an index at one time, but if they've dropped significantly in value, they will eventually be replaced by more successful companies. The indexes are always being replenished by dropping the losers and replacing them with winners. Looking at the major indexes tends to overstate the resiliency of the average stock, which does not necessarily bounce back. In fact, many companies never regain their past highs and some go bankrupt.
 Investors Do Not Like Admitting They've Made a Mistake
 
By avoiding selling a stock at a loss, many investors do not have to admit to themselves that they've made a judgment error. Under the false illusion that it is not a loss until the stock is sold, they elect to continue to hold a losing position. In doing so, they avoid the regret of a bad choice. After a stock suffers a loss, many investors plan to hold onto it until it returns to its purchase price. They intend to sell the stock once they recover this paper loss. This means they will break even, and "erase" their mistake. Unfortunately, many of these same stocks will continue to slide.
  • Neglect.
 
When stock portfolios are doing well, investors often tend to them like well-maintained gardens. They show great interest in managing their investments and harvesting the fruits of their labor. However, when their stocks are holding steady or are dropping in value, especially for long time periods, many investors lose interest. As a result, these well-maintained stock portfolios start showing signs of neglect. Rather than weeding out the losers, many investors do nothing at all. Inertia takes over and, instead of pruning their losses, they often let them grow out of control.
  • Hope Springs Eternal.

Hope is the belief in the possibility of a positive outcome, even though there is some evidence to the contrary. Hope is also one of the primary theological virtues in various religious traditions. Although hope has its place in theology, it does not belong in the cold hard reality of the stock market. In spite of continuing bad news, investors will steadfastly hold onto their losing stocks, based only on the faint hope that they will at least return to the purchase price. The decision to hold is not based on rational analysis or a well-thought-out strategy; and unfortunately, wishing and hoping that a stock will go up does not make it happen.
     . Realizing Capital Losses

Often you just have to bite the bullet and sell your stock at a loss before those losses get bigger. The first thing to understand is that hope is not a strategy. An investor has to have a logical reason to hold a losing position. The second point is, what you paid for a stock is irrelevant to its future direction. The stock will go up or down based on forces in the stock market, the stock's underlying fundamentals and its future prospects.
Let's look at a few ways of assuring a small loss does not become "dead" money or turn into a much larger loss.
  • Have an Investment Strategy
    Having a written investment strategy with a set of rules both for buying and selling stocks will provide the discipline to sell stocks before the losses blossom. The strategy could be based on fundamental, technical or quantitative factors.

  • Have Reasons to Sell a Stock
 
An investor generally has quite a few reasons why he or she bought a stock, but typically no set boundaries for when to sell it. Don't let this happen to you. Set reasons to sell stocks, and sell them when these things occur. The reason could be as simple as: "Sell if bad news is released about corporate developments".

  • Would You Buy the Stock Now?
 
On a regular basis, review every stock you hold and ask yourself the simple question: "If I did not own this stock, would I buy it today?" If the answer is a resounding "No", then it should be sold.

Tax-Loss Harvesting Strategies

A tax-loss harvesting strategy is used to realize capital losses on a regular basis and provides some discipline against holding losing stocks for extended time periods. To put your stock sales in a more positive light, remember that you receive tax credits that can be used to offset taxes on your capital gains.

 Conclusion
 
Taking corrective action before your losses worsen is always a good strategy. In investing, avoiding losses entirely may not be possible; successful investors accept this and try to minimize their losses rather than avoid them. Selling a stock at a loss and receiving a tax credit is one benefit you will receive. Selling these "dogs" has another advantage too - you will not be reminded of your past mistake every time you look at your investment statement.

50 comments :

  1. Hi VP Sir, Thanks for very useful article. Your views on jubilant industries. Will it show growth after selling loss making retail business.

    ReplyDelete
    Replies
    1. As of now not tracking Jubilant Ind.

      Delete
  2. Good lesson sir ji, thank you.

    ReplyDelete
  3. Hello Sir,
    Sir your valuable inputs regarding Divyashakti Granites
    Frontier Springs

    Thank you sir..

    ReplyDelete
  4. On July 24th you commented on moldtek, after results what's your view, still steam left to go up.
    (I'm holding shares, shall I book, or future is better for that ?)
    Thanks sir.

    ReplyDelete
    Replies
    1. Asian Paints setting up its biggest manufacturing plant in AP. This is expected to augur well for Moldtek in long term.

      Delete
  5. One should cut loss in SKM Egg?

    ReplyDelete
    Replies
    1. Now ? . When I felt some negative factors I suggested to exit from it and that was even 100% above current rate . It was not a single one word SELL suggestion but I explained my rationale for my opinion .What negative you are seeing now in its business more than what I mentioned at that time and even after a correction in price.?

      Delete
  6. Your view on CMIFPE and WPIL at current level ? is it right time now to buy cyclical beaten down stocks ?

    ReplyDelete
    Replies
    1. Not tracking CMIFPE

      WPIL earlier suggested @ Rs.180 , at CMP Rs.380 nothing new to comment .

      Delete
  7. Sir
    What is your opinion about MPS limited. Thanks.

    ReplyDelete
  8. Dear VP ji
    Pls share your opinions on
    1.Butterfly
    2. Ifb agro. Thanks

    ReplyDelete
    Replies
    1. Let us hope good monsoon and implementation of pay commission suggestions will boost the spending power of people and some positive impact on white/brown goods manufacturers in long term.

      Not tracking IFB Agro

      Delete
  9. Hi VP
    Any idea about the following scripts

    pioneer distillery and saven technology

    ReplyDelete
  10. Sir your views on Mic results and also of the updates of businesses and waiver of sbi interest.

    ReplyDelete
    Replies
    1. At this stage , Debt reduction is the most important point to note.

      Delete
  11. Dear VP, sincerely hope you are in fine nick! Can you please give your views on latest Q1-17 result of Mic Electronics? Do you think positive about the Company's prospects goingforward? Warm regards!

    ReplyDelete
  12. Sir please give your view on kokuyo camlin and indian hume pipe company if you are following them.

    ReplyDelete
  13. Dear sir,
    Your views about the muthoot capital service after IT raid. I am holding its share. What one should do in this case?

    ReplyDelete
    Replies
    1. Nothing to comment without any idea about the outcome.

      Delete
  14. Hi Sir your View on GEECEE ventures as it came up with pretty good set of numbers , has come down 20-25% from recent highs.Please Update

    ReplyDelete
  15. Sir, what is your view on Gujarat Borosil after Q1 results announced today?

    ReplyDelete
    Replies
    1. More than result, waiting to get some clarity on fund raising for capacity expansion.

      Delete
  16. Hi VP Sir,

    Your views on Exide Industires and Lakshmi energy for long term? Also is NR Agrawal good buy at CMP? Thanks in advance for helping us.

    ReplyDelete
    Replies
    1. Not tracking Exide.

      A good company may not be a good investment at any price point.

      Delete
  17. Sir you had given positive views on shree digvijay cement company ltd, now Q1 results are out. How you see the performance of d company and growth potential of d company in near future. Sir, is this company currently having 100% production of its capacity and what are d capacity expansion plans. Sir, in india this is only have presence in gujrat, will they spread their presence in north,south and other developing parts of india to cater growth and earnings. Pls share your valuable views. Thankyou.

    ReplyDelete
    Replies
    1. Answers of these questions are either available in their AR or can be answered only by management.

      Delete
  18. Hi Vp sir
    Regarding Alps industries, I understand that a part of their overall debt (around 30%) is cleared (with RBS).
    Do you know if they have plans to settle the rest?
    -Srinivas

    ReplyDelete
    Replies
    1. Not debt , it was only a contingent liability

      Delete
  19. Any change in your views on valiant communication sir?

    ReplyDelete
  20. Sir..any views about SUMEET INDUSTRIES LTD ?

    ReplyDelete
  21. This is just a word of gratitude for you for being a shining guiding light for us investors. Even though you have stopped giving direct recommendations,you subtle references to any stock has made me research deep into the stock and thus given lot of knowledge through practice in the process. My pre VP/post VP portfolio quality has such a huge difference. Finally, i have become mature in investing in stocks all thanks to you. Please ignore anyone who is selfish enough to expect total spoon feeding from you. Wish you a healthy long life ahead Sir.

    ReplyDelete
  22. Sir your comment on Pioneer Embroideries result out today. Looks good for long term.

    ReplyDelete
  23. Sir
    Your comments on Amulya leasing results

    ReplyDelete
  24. Hello VP sir.
    GUJRAT BOROSIL- Whats your current view on management and sector as well.positive ,negative or neutral for next 2-3 years period.

    ReplyDelete
  25. Dear sir
    Willing to know your views on newly listed quess corp, advanced enzyme.
    Can one enter now or will wait for correction. Thanks

    ReplyDelete
  26. Dear VP Sir,

    Your views on your old pick Multibase India?

    Thanks

    ReplyDelete
  27. Very Useful Article...Felt as if its was addressed to me in person. Thank you Sir...

    ReplyDelete
  28. Dear VP sir
    Very valuable Thank You
    Sir

    ReplyDelete

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