Tuesday, 29 May 2018

3 Reasons Why Retail Investors Find it Hard to Cut Loss

There is this investing words-of-wisdom in Chinese: 会买的是徒弟,会卖的是师傅。Essentially it means it is relatively easy to buy a share, but when to sell is much trickier. Buying is like elementary school level, but selling may be a high school level manoeuvre.

What about selling a loss position, ie cut loss? What level does is it? PHD?

While I have no answer for that, I do have some opinions on reasons that make most retail investors not willing to cut-loss.



It Will Come Back Up Again
Perhaps this is due to the old adage, or common belief that, over the long term, stock market always go up. But the thing is while the whole market tends to move up, there are some shares that just languish and never rise back up again.

Now there are many reasons that investor bought a landmine stock. Most common reason could be error in stock analysis. Fundamentals wise, perhaps the company is in a sunset industry, or its fundamentals deteriorate and it stops growing. Or it could be due to market reasons such as short-seller attack etc.

So investors in this situation hope that the broad statement will apply to their stock. But unfortunately investing does not really work on basis of hope and hope can be an expensive word here.

We can't accept broad sweeping statement (like above) blindly and apply them to our loss-making positions. Market tends to move up over time no doubt. But market has a self-correcting mechanism in place, as new, stronger companies emerge and join the stock market. But individual stocks is different. Their share price will under-perform, if company fundamentals turn bad.

Cutting Loss Means Losing Money
I came across investors who are surprised at my decision to cut-loss. 'That means losing money isn't it!', they exclaimed.

I believe there is a mental barrier here that treats cutting loss as against the very basic of goal of investing: to make money. And cutting loss means the exact opposite - take the loss,  which is like a cardinal sin of investing which they find it next to impossible to swallow.

So to avoid losing money, they hold. But if a company is rotting from the inside, its share price keeps falling, there is no reason of holding on to an ever-shrinking position.

Nope, hope (first point), or paper loss is not real loss, are not reasons.

How to deal with this? Firstly, recognise that every single investor makes mistake. Even Warren Buffet bought wrong stock and cut loss too, such as his stake in IBM, and $440m loss over Tesco.

Second, accept that losing money is part of investing. What matters is to limit our losses, and let the winning positions run.

I run the risk of providing 'un-actionable' advice here. But fact is cutting losses is never a matter of method or there is some practical ways to do that consistently. It has got to do with your mind largely. We just have to adjust to the right frame of mind, and do it.

Investors View Their Holdings Individually Not As a Portfolio
The last reason is framed at a higher level of portfolio management, instead of pertaining to individual stock or mindset.

I always emphasise on building a portfolio, a basket/collection of different type of stocks. When it comes to decisions such as buy, sell, add, reduce, cash level, they are to be done at a portfolio level. It helps investors to be less myopic about individual stock in a losing position, as overall, the portfolio are in the green, and perhaps giving out good dividends.

And when you look at the profit/loss, look at the grand total - last line of your portfolio table. The percentage there, is much easier to stomach for investor. Focus less on the profit/loss of each line item.

If one does not have a portfolio per se, or is too obsessed with treating each share holdings in silo instead of part of the bigger, more strategic picture, he would be un-willing to cut loss. Then this becomes a case of missing the forest for a tree.

Worst thing is the loss position keeps snowballing and exceed the total profit of all other holdings. Then that is truly unfortunate.


Want to find out more about how to builds a resilient portfolio of stocks? Sign up for my next sharing here

Other topics I will cover include various instruments suitable for retail investors, how to determine quickly the quality of selected stock and ways to safeguard your profit and protect your assets. 


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