Human beings have a tendency to accumulate possessions. Over time, our closets, garages and sheds fill up with all sorts of things—some useful, and others less so. In my neighbourhood, people might have one or two garages. But they still park outside all year round, since their garage is full of old things they don’t even need.
The same is true when people play the stock market. Most people lean heavily towards buying; the decision to buy a stock is much less fraught than the decision to sell. That’s why many investors passively watch their stocks go down, telling themselves that they’re sure to bounce back—good news is sure to be just around the corner! But by putting off the sale, they end up doing nothing as their investment continues to lose value. It’s simple: When a stock goes up, investors don’t want to sell because they hope it will keep on rising. When prices fall, they cling to the hope that the stock will bounce back.
That’s the approach most people take. If you don’t have a trading strategy, you’ll just end up injecting cash into the market—and making money for other people.
Imagine if we could cancel out all the big losses from the past? We’d
all be so much better off!
Managing loss effectively is an essential part of investing in the stock market. Otherwise, losses can have a significant impact on the overall performance of your portfolio. Let’s say you buy a stock at $10 and let its value slide for a month until it hits $2. The value of your investment will have declined by 80%. If you hold onto it in hopes of a recovery, it would take a 400% increase for the stock to reach $10 again and cancel out your loss. So you can see that it’s not enough to pick the right stocks—you also need to know when to dump a declining stock before your portfolio’s performance is too severely affected. For example, as illustrated in the graph below, in August 2015, Valeant Pharmaceuticals (T-VRX) was trading at just under $345; by May 8, 2017, it had fallen to under $14—a loss of approximately 96% of its value. To go back to its 2015 prices, its value would need to increase by more than 2,450%.
The stock market is like a game of snakes and ladders. You need to take advantage of upward trends while avoiding downswings. To play the market well, you need to leave less room for chance. Your knowledge, analysis, strategies and discipline will make all the difference. When it comes to the markets, will you be the hunter—or the prey?
Why didn’t I simply call this section “Avoiding losses”? Because it’s just not possible to eliminate all losses. However, there are ways to avoid suffering major losses—or an excessive number of small losses.
I’ve spent my life studying the markets; in that time, I’ve noted predictable trends that have very high success rates. Proponents of technical analysis see all other approaches as nothing but fantasy.
Of course, you need to learn to select the securities with the strongest growth potential. To do so, you have to go where the action is. Investors need to establish an exit strategy to limit loss in case a stock starts trending in the wrong direction. They should also have a strategy to take advantage of rising stocks. Before you buy a stock, make sure you can answer the following three questions:
I’ll address these topics in the coming months. To hear me discuss the markets, tune in to the free Swing Trading Show, available online every Wednesday at 12:30 pm on Decision-Plus. It’s also available as a recording.
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