One lesson every investor learns over and over again is to limit, or cut your losses. A huge part of investing is emotional discipline, and it's common to fool yourself into thinking a losing position will recover. In Warren Buffet's words, "Rule one is don't lose money. Rule two is never forget rule number one!"
When you pick a losing stock and quickly take a loss, it's easy to think that you will recover the loss and the stock will go back up. After all, you bought the stock because you thought it would go up, and "it just hasn't gone up yet." Thinking this way is a mistake. Unfortunately, I have a great example of this with Chewy (CHWY), which I bought in Poppy Seeds for about $100, and now it is about $70. I still think Chewy is a great company with a great pet food subscription business, but the stock performance has caused me to lose 30%. Will it ever come back? Maybe. My timing was unlucky, at the very least. Whatever my investment is still worth today would likely be better invested in something that is actively making money instead of losing it.
If you don't protect yourself from potential losses, it's easy to think irrationally during market swings. See the screenshot below from a recent day when the market tanked, but Chewy didn't. My irrational mind was thinking, "Great! The market obviously sees good value in Chewy like I do, even during this selloff. Surely Chewy will recover soon to the $100 price per share I paid for it." Spoiler Alert - it hasn't recovered and is currently around $68, down another $7 from the day in the screenshot.
Loss Cutting Strategies
So what can you do to cut your losses and control your emotions? There are a few things:
- Write down what % loss or $ share price you are willing to lose when you are buying something and can think about it rationally.
- Use a Stop order to automatically sell your losing stock when it drops to a specific price. For a risky stock, it might be a good idea to place one of these orders immediately after buying and keep the order active for many weeks or months to protect you from a significant loss. This is an excellent tactic because it completely takes your emotions out of the equation once you enter the Stop order. There are subtypes of stop orders, such as stop limit (shown below for my Chewy holdings) and trailing stop, which automatically adjusts as the stock price increases. My stop limit order below will automatically sell Chewy when the price hits $67.67, and it is valid until January 7th 2022.
- Talk to friends and family about a loss you've taken on something so they can help you think rationally about your position! (Selling to cut your loss is probably the right move)
- Connor bought VIOG, a small cap growth ETF with about $1800.
- Nick sold CHWY for about $338 when the price hit his stop order price of $67.67 on Thursday.
- Brenna, Spencer, Lindsay, Chloe, Antonio, and Garrett are still sitting on the additional $1000 in cash.
In the Poppy Seeds spreadsheet detailed tab, you may have noticed the red/yellow/green formatting to make losses really catch your eye:Green = you are making money
Yellow = You're down 0-10%
Red = You've lost 10% or more and should consider selling
@Chloe and @Milena - You should consider selling Beyond Meat and AppHarvest. Both are down about 45% since you bought it.
Please remember to update the google sheet detail tab when you buy/sell something. I look at the revision history each month so I can include your trade in this newsletter. The summary tab is at the bottom of this email as a picture and the live link to it is here.