When should you cut losses on a declining stock?
Going by a famous quote by Yvan Byeajee, “Trading doesn’t just reveal your character; it also builds it if you stay long in the game”. To stay long in the game, it is important to have a good understanding of how the stock market works. The volatility of the market usually gets to the investors after a point, which is when they start making wrong investment choices.
Making losses and gains is a normal occurrence in the world of investments. In fact, anyone can make money by picking the right stocks but knowing when to hold them (the stocks) and selling them can make a huge difference. It is this wisdom that separates successful investors from the not so successful ones.
So, when should you stick to your stocks and when should you cut losses on a declining stock? Read on to find out.
Mastering the art of losing
Surviving in the investment world requires you to master the art of losing. Many a time, it is our repugnance to make a loss that keeps us from selling a stock that is declining. Sometimes it is important to our ego to make the right choice by selling off your stocks even though they are making losses. Even in the field of martial arts, Judo masters begin by teaching their students how to fall as opposed to how to throw. This is done to inculcate a sense of resilience in them. So no matter how many times they flip, they will know they are in a position to rise and fight again.
To survive in the stock market, it is imperative that you learn this skill. Sometimes our stubbornness to let go of the bad stocks keeps us from doing damage control at the right time. This leads to further losses. Highly successful stock investors know how to cut their losses short because they are wise enough to let go of the failing stocks at the right time. Maybe this is why investors are usually asked to ‘take emotions out of their investing strategy’.
If think about it, what would you prefer? Selling your stocks when they are 7% or 8% lower than their purchase price or when they are 20%-30% lower? You know what needs to be done here.
Consider these factors to deal with a losing stock
Reason for investing in the concerned stock
Firstly, when you reach this stage, you need to ask yourself why you invested in the stock in the first place. There is a high likelihood that you must have made the investment decision based on some solid reasoning. You may have thought that the stock is underpriced when compared to other companies’ stocks. Or you may found a stock that you thought would do well in the long run. The point is you would have done some analysis and forecasting while purchasing the stocks in hand. Based on this reason, you can identify if you should hold these stocks or sell them.
Dinesh Dayani of Dollar and Sense explains this well in the following excerpt:
“If you’d like to choose to buy more of the stock and average down the purchase price. This means you continue to believe you have made the right decision in investing in the company in the first place, despite its current struggles. If that’s the case, it may be a good idea to hold on to this investment for now and to ride out market volatility in the short-term, rather than to panic-sell”
On the other hand, if you believe that your earlier analysis was wrong, then you know what needs to be done next. The intention is not to stress you out by talking about right or wrong but to be aware of when you should cut your losses.
If the ownership of the company has changed
Sometimes what happens is when you purchase the stocks from a particular company. You have done your forecasting based on the ownership of the company. But after a point, the company is bought by another entity and the fundamentals of the company changes. What you thought of as a good company at one point is no longer the same, which in turn impacts your stock price. In such cases, you should reassess the growth potential of the company. This could mean going over the balance sheet of the company, the current financial records, etc.
Setting a stop-loss target
It is always wise to have a set target when it comes to the amount of money you are willing to lose. One easy way is to set a target for yourself. If a stock falls below a certain price level, for example, you would simply sell, regardless of the reason. This way, you never risk more than a fixed percentage of your portfolio, and you’re still able to let your good investments ride upwards. Yes, having a stop-loss target can lead to some regrets in the future, when you see some of the stocks that you sold off eventually recovering.
We hope these tips will help you decide on when to sell stocks at a loss. At the end of the day, it is either about making profits or making the smallest loss possible in the stock market.
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