Advertisement
Breaking Bad Trading Habits

When to Admit You Made a Mistake

Trading and investing is a tricky business.  As the Judge in ‘My Cousin Vinny’ said, Win some, Lose some.  If we’re on our game, we’ll get far more right than wrong, but sometimes the ego gets in the way of clear mind and we end up holding trades longer than we should.  Nobody can see the future and have 100% perfect timing.  There will be losses, it’s just part of the game.  However, we don’t have to treat this like a casino where we have little to no edge.  The time-tested technique of technical analysis and charting can help keep us out of a difficult situation. 

Let’s use an example for a case study.  An investor/trader has a fundamental bent on the stock of Twitter, and has been accumulating the stock for a long while.  The chart is below.  The cost basis is probably in the mid to high 30 dollar range.  As of the close on Dec 24 Twitter stock is trading just under 23, so this person is likely sitting on a 30% loss or more.  The stock is well under the cost basis, but this investor continues to buy the stock on the way down, lowering the cost basis but increasing the risk of the overall investment.  Did this person in the beginning have a goal of accumulating a certain amount of shares or dollar value?  This investor/trader clearly wanted the stock higher, but most certainly loves the stock even lower. 

Now, maybe this investor is a value player – seeing enormous potential as Twitter stock may be mispriced.  Why is the price going down?  Institutions and insiders are selling the stock repeatedly, but why?  Don’t they know Twitter growth is going to continue over the long term?  Don’t these sellers see this is going to be a missed opportunity?  There is a reason institutional sellers are active – they see lower prices ahead.  Some of that instantaneous selling feeds on itself and we see prices continue to deteriorate.  How can one possibly just stick their hand in and catch a falling knife perfectly and time it right?  It’s just not common.

If we look objectively at the chart, we can see there were few signs to get on board Twitter from the long side.  Sellers have been hitting the bid and distributing the stock for months. If you owned the stock, you have been hammered.  However, being disciplined and placing a stop loss at a certain level would have us out of the name before any major damage was inflicted.  William O’Neill, one of the greatest investors of our time preaches taking no more than an 8% loss.  Why that number?  To recover that loss only requires an 8.7% gain on the next trade.

Did this person have a plan to keep on buying Twitter lower in the beginning, or is this a case of not being able to admit a timing error?  I don’t know the answer to that question but with more capital at risk it is certainly easy to cover up a mistake.  This is a classic error that many novice investors make to help feed their ego.  Unable to admit they are wrong or defeated on an idea, they tend to ‘double down’ on a mistake hoping to get bailed out on a longer time horizon. 

Putting more risk on a losing position just creates a bigger loser, more worry, more doubt and acceptance of an action that was never part of the original plan.  In most cases, it just doesn’t work – and the opportunity cost (could the capital have been used elsewhere?) is enormous.  Your mind may seem satisfied at the time, but there is no mistaking there is a bigger risk taken.

I have had my share of mistakes, trades gone awry.  But I will let each trade stand on its own merit, and since I cannot predict the future – I will be on the wrong side of the trade at times.  My biggest move in that case is to accept I’m wrong and cut bait.  One of my most popular e-books (downloaded for free on www.explosiveoptions.net) is ‘The Art of Selling’, which tells about the most liberating experience you will ever have.  Push the ego away, accept a mistake and move on and just sell.  Your next investment/trade may be the one to remove any doubt.

twtr_weekly_122815.jpg