To exit or not to exit. A Risk Management Lesson

 

You buy a stock, for whatever reason. Then it starts to trade lower and lower, you're now not sure if you should exit or not. It doesn't matter whether the buy decision was good or bad, the assumption is that you had conviction on the buy.

You have two option; exit or keep the position. I don't recommend changing from being a Trader to being a (value) Investor at this point.

Exit

You take a loss, hopefully a small loss (< 2% of your total portfolio, position sizing) and move on with your life. You could be wrong and the market start to reverse, but heck you'll sleep better from now on. Your account will also recover quicker.

Stay

The market continue to fall, that initial -10% is now -35%. You don't want to exit now because the loss is bigger. You continue to stay, down another 10%. You can no longer handle the loss emotionally, and there's an amateur who keeps on saying "you only lose when you sell."

One day your emotions will be too strong for you and you'll be forced to exit at with a large loss. See, there's no point sticking with a losing position.

1. It may not recover.
2. Even if it recovers, it'll take time. During that time you'll miss a lot of opportunities because your capital is tied in a losing position. Opportunity cost.

Take home message

1. Predetermine your exit levels, for profits and losses. Plan ahead.
2. Exit when the exit level is hit, don't second guess it. It's easy to turn a winner into a loss, you can turn a small loss into a large loss.
3. You don't have to be right, or try to prove that you're right and the market is wrong. There's only one side of the market, the right side. You're there to make money not to stroke your ego.

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