Understanding Stocks

158 UNDERSTANDING STOCKS
Mistake #1:You Don’t Sell Your Losing Stocks
For a variety of reasons, some people hold onto their losing stocks too
long. Failure to get out of losing positions early is probably the number
one reason why so many investing and trading accounts are destroyed.
The reasons people hold onto losing stocks are primarily psychological.
If you sell a stock for a loss, you deride yourself for not having
sold sooner. Adding insult to injury, you have to admit that you lost
money. No matter what price you sold the stock at, it always seems as
though you could have done better. Many people think they can’t be
wrong about their stock picks or are seduced by hope and greed. Others
convince themselves that a stock will come back one day or are
afraid to “throw in the towel.”
During the bull market, not only did people not get out when their
stocks fell 10 or 15 percent, but they bought even more shares.
Although there was still plenty of time to get out of the market with
minor losses, many people refused to sell their losing stocks. It took
3 years of a bear market before many people realized that they had held
on too long. (By the time you’ve lost 80 or 90 percent of your investment,
perhaps it really is too late to sell unless you want a tax write-off.)
To keep your losses small, you need a plan before you buy your first
stock. One rule is so important that you should post it in front of your
computer or on your desk: If you lose more than 10 percent on an investment,
sell. You lost, so you sell the stock. You can put in a stop loss order
at 10 percent below the purchase price when you buy the stock, or you
can make a mental note. The main point is that you take action when
your stock is losing money. (Some stock experts, such as William
O’Neil, publisher of Investor’s Business Daily, recommend selling losing
stocks at 8 percent.) Even if the company looks fundamentally
strong, if the stock is going down (for reasons that may not be immediately
apparent), there is only one response: Use the 10 percent rule.
(There are exceptions, of course. If you buy a stock at what appears
to be the bottom and it makes a long sideways move before losing 10
percent, it is acceptable to hold it, especially if you anticipate future
gains. The 10 percent rule is designed to prevent undisciplined
investors and traders from letting a small loss turn into a large one.)