Behavioral finance tells us that stock market declines tend to be quicker and steeper than gains because the fear of loss is twice higher than the desire to profit.
The PSE index has so far lost more than 1,300 points or 13.7 percent from its peak this year and could lose some more to as low as 7,400 in the coming weeks. While it is expected for the market to rally on the way down, it should consolidate at some point once the selling wave is over.
If you are holding on to some stocks that are losing, should you cut your losses now or wait for it to recover? Although blue-chip stocks do recover for sure in the future because institutional investors will always buy them back when market sentiment improves, there are stocks that may never recover at all.
Holding on to these stocks believing that they will bounce back someday while your losses mount as share prices fall may be financially damaging. Perhaps, instead of hoping to break even, you should find out the chances of the stock’s recovery based on its fundamentals.
If there are no fundamental bases for you to hold on to the stock, it may be better to sell it now and end your pain. You can use the proceeds to buy another stock that is more promising to help you recover your losses later on.
Losing your hard-earned money in the stock market can be an emotional issue. You may never want to invest again after this for fear of another loss. The trauma and experience that you went through may discourage you from investing in stocks again.
If you want to become a successful investor, you need to handle your losses by managing your emotions and moving on. Here are the five things you can do when you try to deal with investment losses:
1. Own up to your losses
Accept that you made a mistake. Maybe you had the chance to sell the stock at a good price but you delayed it hoping that it would go higher only to miss it when the stock started to fall sharply. Or maybe you were taken by emotions when you bought the stock at a high price.
You may feel anger and resentment at your stockbroker who gave you the wrong recommendation. You may also feel betrayed by the people you talked to for investment advice. How come they did not advise you to do something to prevent you from losing?
It is easy to blame your broker or friends who gave you the wrong tips but at the end of the day, it is you who should become responsible for your losses because you made the decision to buy.
2. Put your loss in the right perspective
Taking a capital loss, especially when it has already ballooned, can be devastating not only financially but emotionally. If you are the type who cannot express your feelings properly, you may suffer from emotional grief that may lead you to depression.
For example, you may equate your losses in the stock market as your personal failure. The thought of losing a lot of money in stocks will always haunt you and make you feel like a loser.
When this happens, try to think about when you had the worst problem in your life and how you managed to overcome it. Whatever financial losses you may have incurred, take comfort in the fact that you will always have a second chance to make it right and recover in the future.
3. Manage your risks by limiting your losses
Once you have learned your mistakes, make sure that you will never commit the same mistakes again in the future. Come up with a better plan that will cater to your risk appetite and investment goals.
For example, if you are careful this time not to lose so much money, you can try to diversify your investment portfolio by limiting a certain allocation percentage per stock.
Let’s say you will budget each stock to have maximum allocation of 12.5 percent only so that when you need to sell this stock at 20-percent loss, the total damage to your portfolio will only be 2.5 percent.
You can also put a stop loss for every stock you buy to budget the losses that you can tolerate. For example, if you bought a stock at Php100 per share and, assuming your maximum tolerable loss is 10 percent, you would need to cut your loss by selling the stock when its share price falls to Php90 per share.
4. Learn to invest better by honing your trading skills
If you feel that you lack the knowledge and skills to execute a sensible investment strategy, you should invest your time reading books or attending seminars.
When you know more about investing, you will feel more confident in making a decision to buy or sell stocks. You will rely less on recommendations and tips from other people and become more independent with your stock picks.
Always challenge yourself to learn something new about investing. Do your research and make your own opinion. The more you learn, the better your decision-making will be.
5. Take a vacation and unwind
If you are experiencing too much emotional stress that it is already affecting your investment judgment, it is advisable that you take a break from investing and get a vacation.
Try to recharge your mind and body by resting. While taking your vacation, review the steps you took before you came up with your trading decision.
What were you thinking when you tried to chase the stock at a high price? What were your regrets and how should you avoid this next time? Did you feel panic when the stock was falling? How should you manage your risk and control your losses?
Losses in the stock market are normal. It is not the loss itself that matters but how you deal with it. If you can’t handle the heat, take a break and relax.
Henry Ong, RFP, is president of Business Sense Financial Advisors. Email Henry for business advice firstname.lastname@example.org or follow him on Twitter @henryong888