LIKE THE RING toss at the carnival and rollerblading at the beach, investing always seems easier than it really is. You can be correct on the sector but wrong on the stock. You can be correct on the timing but wrong on your position size. This is a game where there’s slim margin for error and plenty of opportunity to do the wrong thing.
When it comes to stock picking, I’m hit or miss. No matter how much research or analysis I do, many of my stock picks end up going exactly the wrong way. Although it’s tempting for investors to brag about gains, it’s how they deal with losses that really matters.
During the 1990s bull market, losses were a problem that nobody seemed to have. After three years of a bear market, however, most investors are now aware that not every investment goes according to plan. To that end, they’ve become more sophisticated: Hedging and stop-loss orders are a few of the strategies that have become part of many investors’ repertoires.
But dealing with emotions can be just as difficult as wrestling with the market itself. Perhaps even tougher. Trading, even when done right, can really mess with a person’s mind.
Like booster shots and final exams, much of the anxiety of a losing trade comes before you actually make it. The best way to begin to deal with a loss emotionally is to get rid of it — that is, to take the loss and move on to the next trade. I know far too many traders who drag around losing positions for months on end. Not only is this a poor use of capital, but it serves as a constant emotional downer that wreaks havoc on one’s self confidence and pride. Hold on to a loss, and you’ll face it every day. Take the loss, however, and it’s gone.
Then again, the loss is gone, but so is the money — and let’s be frank, that hurts. I’ve traded everything from stocks to soybeans, and I can assure you that losing money never gets easier. When I’m wrong — and I’m often wrong — I feel like an idiot. A fool. A loser. A jerk. I turn into a walking, talking shame spiral. It’s not a pretty sight.
What makes a trader so emotionally vulnerable is that he has no excuse for his misfortune. Oh, sure, you’ll hear people blame losses on Greenspan, or Bush, or Martha, or those pesky hedge funds. It’s natural to want to look for a scapegoat. But in this business, we reap what we sow, for better or worse.
The trick to dealing with the inevitable lows of trading is to be able to keep your trading and your personal psychology separate. You’ve got to give yourself the permission to be wrong once in a while. Just because you lose money doesn’t make you a bad person. Get in the habit of reminding yourself that your net worth isn’t your self worth. When losses come (and they will), you must think of them as part of the trading game, not a personality flaw.
Although it’s unsexy compared with active buying and selling, maintaining good fiscal discipline is of paramount importance. Nobody likes to lose money, but you’ll undoubtedly find, as I have, that it’s much easier to deal with losses with the knowledge that you’ve got other assets, namely savings, that aren’t affected by the market’s moves. If you live below your means, avoid debt and maintain some noninvestment savings, a loss might rock your boat, but it won’t sink it all together.
This is the main reason why it’s so important to trade only with risk capital. Not only does it give you the financial flexibility to take a loss, but also the emotional flexibility, if you will. Losing trades are just part of the game, and the point isn’t to be right every time, but over time.
– Originally on Jun 23, 2003 by Jonathan Hoenig
