With the stock market looking weaker by the day, and omens of recession coming from every corner of the media, its time to take a look at what to do if you get caught in a bad trade. No one wants to be stuck in a losing position. You might have guessed that the stock would go up, but jumped in too early and it crashed. You might have had a strategy but got distracted by life for a few days and didn’t get out in time.
Either way, lets go through a number of strategies for selling a position listed from the best to worst.
1. Exit Immediately
The best tactic – but also the hardest to execute psychologically – is to exit the trade immediately. Its a no-brainer. Everyone and their mother who has ever done a little bit of research on how to trade stocks will tell you as much. If you’re down 10%, get out and don’t look back. It’s easy to make back a 10% loss on a position – it gets exponentially harder the farther down you go. It also takes you longer to recover – and time is the one thing you can never get back.
So, if it isn’t too late you should exit immediately.
2. Sell to the Sleeping Point
This saying was pioneered by legendary stock market trader Jesse Livermore (one of whose books I reviewed here).
If you can’t exit immediately, for psychological reasons, then the next best alternative is to exit part of your position (1/3 – 1/2 of the total) to minimize your losses. This is crucial to break that mental stranglehold that a trade can have on your mind: that any loss is equal to personal failure, to admitting that you were wrong. Once that sale done, you can wait for the market to recover and save the other half of your trade, you can redeploy your cash capital elsewhere, or you can now exit the position completely.
Either way, this greatly decreases stress in your life, especially if you trade in larger sizes. If you made a mistake, and it is affecting you to the point where you’re distracted from work or can’t sleep at night, then you need to address it immediately. Sell the position to the point where you are comfortable with it again, i.e. the sleeping point.
3. Average out of Losing Trades
A third strategy is one I call Profit/Loss averaging. WIth this strategy you take profits from X position to pay off losses for Y position and slowly exit the Y trade. This is obviously a delicate procedure and takes time to carry out, but is a viable option for traders who have been around long enough that they can read a chart and know where a stock will go in the short run.
4. Average Up/Down
Lastly, you can put more money into buying/shorting a stock and averaging your position into a favorable direction, with the hope that with this new average that the market will recover.
While good in theory, this is a risky move. You may be buying into the teeth of a crashing bear market or shorting against a soaring bull market, jeapoardizing even more of your hard won cash than before. If you’re lucky the market will eventually turn and you’ll break even with no cost other than your time (which is precious enough!).
If you are unlucky though, you may be buying a company that is in its death spiral. The management is incompetent. Profits are crashing. The competition is stealing all their customers. There isn’t enough money in the coffers to weather the downturn. The company may simply never recover and you can lose everything.
Conversely, if you are shorting a stock it may turn out to be the next Google or Amazon. The price soars through the stratosphere as the companies bring new products or services to the market and reap profit hand over fist. You can easily go bankrupt before the company matures and starts taking hits like other older companies.
Naturally, while this strategy is the riskiest it is also the most common. It is comforting psychologically as people don’t have to admit they were wrong about a trade. Their pride is worth more than their money or their time and they double down. Try to avoid this if you can!
As you can see, there are a variety of ways for you to exit a position if you are worried about its future. If it’s causing you even a twinge of concern, look at these strategies and plan your next move in advance. Set markers for when you need to exit a position no matter what, and follow them to the letter.
For further reading though, I strongly suggest Donald Cassidy’s It’s When You Sell That Counts. I will address it at some point in a book review, but will tell you know that it’s worth it’s weight in gold.