Monday, August 31, 2009
I heard the four dirty words of trading last week...
My friend had recently purchased stock in a small oil company for around $20 per share. Things weren't going well for the company, so its share value was down to $8 – a 60% loss for my friend.
Here's what he said: "It will come back."
I shuddered at his analysis of the situation. I shuddered at those four dirty words.
This is the mantra of stock market losers. If you catch yourself making this statement, immediately sell all your stocks and stick the cash in the bank.
You'll be much better off financially if you do. You'll also have a lot less stress in your life.
"It will come back" is a common reaction investors and traders have after seeing a stock fall 30%... 50%... or 70%. Most folks just can't stand to admit they're wrong. Saying "it will come back" allows them to convince themselves they aren't wrong... just "early."
It allows them to keep hope alive... and to ignore the elephant in the room: They need an absolutely huge, highly improbable gain just to break even.
Consider this: If you buy a stock at $20 and it sinks to $8, you need a 150% gain just to get back to breakeven. We all know how rare a 150% move is. Saying "it will come back" ignores the overwhelming probability that you are sitting on a loser that will keep losing.
But most folks don't consider the odds when it comes to putting their hard-earned money in the stock market. That's why the majority of folks lose. That's why Wall Street firms have such beautiful, expensive buildings with lavish furnishings.
Many folks have 10 or 20 worthless losers in their accounts that they have moved to the back of their minds... 10 or 20 losers they still believe will "come back."
As I said, the solution for these folks is to sell everything and stick the cash in the bank. If you're one of them, do some housecleaning. If you have a group of stocks that will "come back," face reality and throw them out like yesterday's newspaper. This will clear out your mind and your account.
Getting rid of losers is the cure for the disease. But a better solution is not to contract it in the first place. Use stop losses – the predetermined points at which you will sell positions if they move against you.
Sure, it's a little uncomfortable to face your losers and admit you were wrong. But it's the only sure way to make money in stocks: Use stop losses... realize it's highly unlikely big losers will ever get back to breakeven... and always avoid the four dirty words of trading.
Intel jumps 4% Friday... strong demand forecast pushes several chip stocks to new highs.
Copper a penny shy of $3 per pound after seven straight up weeks.
Sugar surges to 28-year highs... Indian drought adds to a 90% spike in prices this year.