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Your Investment Portfolio: Crucial Investment Habits Every Investor Should Cultivate
by Marc Lichtenfeld, Health Care Expert
Wednesday, October 14, 2009: Issue #1115
One of the marks of a good poker player is someone who can throw away a good hand if he thinks he’s been beaten. A less-experienced player might hang on to a premium hand, no matter what the board, or his opponent’s play may tell him.
Successful investors do the same thing. There’s an insightful trading expression: “Good traders know how to make money. Great traders know how to take a loss.”
The question is: Do you know when to hold ‘em and when to fold ‘em when it comes to your investment portfolio? When you buy a stock or option, you do so having undertaken your research and due diligence. It feels good to be doing something proactive that you expect to have positive results.
Nevertheless, it’s an act of faith – and when the investment doesn’t go your way, taking a loss is one of the hardest things to do following your initial optimism.
I’ve heard people say, “It’s not a loss until you sell.” That may technically be true, but I’ve also seen 10% losses on paper become 100% real-life losses with that mentality. And the truth is, when you sell for a loss, not only are you admitting that you were wrong, but you’re also taking a hit to your investment portfolio.
So with that said, I’m going to do something that is unheard of in this business…
Time to “Brag” About a Loser
Typically, investment analysts love to tell folks about all their investment portfolios and all of the wonderful gains they’ve racked up over the years. Of course, we’re truly happy with the winners and I’m personally very proud of my track record.
But I’m going to break with tradition and “brag” about a loser.
Thankfully, I don’t have too many examples of trades that didn’t work out, but I found one that perfectly illustrates several crucial investment habits that every good investor must cultivate.
In the August 2008 Xcelerated Profits Report issue, I recommended shares of a small medical device company called Somanetics (Nasdaq: SMTS). I did so on the expectation that earnings would increase as more hospitals used the company’s technology to monitor oxygen levels in premature-born babies.
But despite my best efforts, the trade didn’t work out. Here’s why…
The Right Way to Take a Stock Loss
If you remember, mid- to late-2008 was not a great time for the stock market. As a result, SMTS shares fell. In October, SMTS hit our customary 25% trailing stop at $16.46 and I instructed subscribers to sell their shares if they hadn’t put a stop in (which they should have).
But what if I’d been stubborn and let my pride get in the way of this losing stock?
Aside from being irresponsible to my subscribers, it would have been reckless, as shares went on to hit a low of $10.16 in March.
Yes, they’ve rallied with the broader stock market since then and have scrambled back to the mid $16s (where we sold it). But if I’d insisted that my analysis was right and that shares would eventually go up, subscribers would have had to live through the emotional turmoil of seeing the stock drop by more than 50%. On top of that, their money would have been dead for a year.
But by cutting our losses with SMTS, we were able to re-deploy cash into other winning investments, where we pocketed 11% and 21%. We also have a current open position that is up 20% and two that have gained 15% since entering them.
So while we took a loss on SMTS, it’s often better to just move on, rather than wait for the stock to meander back to breakeven, just because you refuse to sell for a loss.
Here’s a quick checklist…
Got An Exit Strategy? Here’s Your 4-Step Checklist…
Keep these four key rules in mind when you’re faced with a position that is in the red…
- Use a Trailing Stop: I cannot stress this enough. Using stop-losses and/or trailing stops is something that all my colleagues here at Investment U advise. Simply put, it takes the emotions out of selling your position and resists the temptation for you to hang on in stubborn hope, rather than solid expectation. Selling for a loss is difficult, but if you have a stop-loss, the position is liquidated automatically. And if the stock creeps to your stop-loss point, don’t change your exit strategy. That’s a recipe for disaster. It’s there for a reason, so use it.
- Don’t Let Trades Become Investments: If you have a reason for getting into a trade, such as a chart pattern or near-term catalyst, and events don’t unfold the way you expected them to, get out of the position. Don’t hang on to the stock if your original analysis has changed. Move on to the next idea.
- Check Your Emotions at the Door: Sure, there are companies and people behind the stocks that you own, but you shouldn’t consider stocks any more than pieces of paper. Don’t assign any emotional value to a company just because it does something cool, or develops cancer drugs. You should buy and sell stocks with cold calculation, not because it gives you a warm, fuzzy feeling.
- Use a Stop-Loss: See #1!
Believe me, I know what I’m talking about. Early in my investing life, I bought shares of a dot com company whose price eventually went to zero. I was raw and let my emotions drive my decision-making and never sold the stock. It makes me sick to my stomach when I recall how much I lost and how I could have avoided most of the pain if I’d employed a 25% stop-loss and exited the position. Even if I’d simply put the remaining money in the bank, at today’s low interest rates, I’d have paid for at least a year’s worth of my son’s college tuition.
Then again, maybe my eight-year-old son will be able to pay for college with his poker winnings. He’s becoming quite the player. Last time, for example, he folded pocket aces when he thought he was beaten. He was. But by saving his chips for a better hand, he then crushed his mom and me!
Hoping your longs go up and your shorts go down,
Marc Lichtenfeld
Editor’s Note: Would you drive on the highway without knowing what exit to take? Of course not. So why would you invest in stocks without having a clear exit strategy in case things go wrong?
Rather than play Russian roulette with your money, take a look at the Investment U course. This step-by-step, easily digestible guide shows you everything you need to know about mastering the stock market, so you can build a seven-figure fortune – from scratch. No complex software required. No elaborate trading systems necessary. No Ph.D in Economics needed. In fact, you don’t even need a calculator. You’ll learn how to progress from humble beginnings and work your way up in an amazingly simple and powerful way. Check it out here.
And for more on how you can profit from Marc’s investments, take a look at the Xcelerated Profits Report. He’s handed readers several double-digits winners and currently has gains in four more health care firms, including one that could be on the verge of bringing a “game-changing” drug onto the market.
- LEAPS vs. Stocks: An Investment Vehicle Throwdown
- Trailing Stops Made Simple…
- Why Doing Nothing is the Right Investment Strategy
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8 Responses to “Your Investment Portfolio: Crucial Investment Habits Every Investor Should Cultivate”
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Marc Lichtenfeld is embedded in the biotechnology and healthcare sectors. As Healthcare Specialist for The White Cap Research Group, his days are spent tracking the clinical trials of various companies seeking FDA approval on pharmaceuticals, which oftentimes means interacting with CEOs of companies.
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October 14th, 2009 at 12:23 pm
Having read Mark Lichtenfeld’s article in Issue # 1115 dated October 14, 2009 and the Oxford Club’s publication titled “Strategies For a Bear Market” I would appreciate it if you could clarify how you would implement the stop-loss strategy if you follow the advice at the end of page 6 of the publication which states “We also base our sell decision on the closing price, not intra-day prices”. Does this mean selling the stock on the following day (i.e. the day after the stock closes below the stop-loss level) at market? Thanks, Nadim.
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October 14th, 2009 at 1:27 pm
Having read Mark Lichtenfeld’s article in Issue # 1115 dated October 14, 2009 and the Oxford Club’s publication titled “Strategies For a Bear Market” I would appreciate it if you could clarify how you would implement the stop-loss strategy if you follow the advice at the end of page 6 of the publication which states “We also base our sell decision on the closing price, not intra-day prices”. Does this mean selling the stock on the following day (i.e. the day after the stock closes below the stop-loss level) at market? Thanks, Nadim.
Oops…forgot to say great post! Looking forward to your next one.
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admin Reply:
October 16th, 2009 at 2:01 pm
Dear Nadam,
Thanks for the compliment! We’re happy that you found it helpful.
As for the stop-loss strategy, yes, you interpreted the information correctly. The closing price is the one that matters, so that’s the one we focus on. If a stock drops below our set stop-loss by the closing bell, we sell it first thing the next available trading day.
Invest U. Research Team
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October 14th, 2009 at 9:12 pm
I have tried to place stops on certain foreign stocks but my broker advised that I could not place a stop on them. Have you had similiar problems with stops? And if so, how did you resolve same? Thanks George
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admin Reply:
October 16th, 2009 at 2:03 pm
George,
Placing stops on foreign stocks that trade on non-U.S. exchanges IS a problem. Most brokerage firms cannot, or will not do it. In these cases you would have to use a “mental” stop, meaning you have to keep an eye on the price and if it hits your designated sell stop… have the discipline to go ahead and sell it.
The other alternative is to switch to a brokerage firm which specializes in foreign stocks… but this may not be worth your while unless you are doing a lot of trading on foreign exchanges
Investment U Research Team
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October 15th, 2009 at 9:32 am
I frequently see articles about using trailing stops for stocks. Does this also apply to Leap Options? Thank you.
davidjray@nckcn.com
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admin Reply:
October 16th, 2009 at 2:00 pm
Dear David,
As with any investment, there are two potential outcomes: You can make money or you can lose money. Because of that, the answer to your question is a definite “yes.” Before or just after entering the trade, determine exactly how much you’re willing to see it drop if things go south. And if it reaches that amount, then let it go.
Investment U Research Team
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October 16th, 2009 at 11:12 am
Very good advice!
Trailing stop for stocks is one of the most important action for stock winning.
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