Tag: Educaational

Smaller Losses and Bigger Gains Come with Mindset

I don’t think I’m a very good businessman. I act too much with the heart. – Pelé

If you treat the holdings in your trading account with any attachment, your ability to sell at the right time will be hindered, and your profit potential will suffer. Ideally, an active trading account accumulates when the selling volume reaches a peak, prices are cheap, and lightens up when prices are sufficiently above the purchase price. Or when there appears to be better used for the account’s capital — including moving to cash equivalents.

The Pelé quote above reminds me of many active traders; they enjoy the rush of playing and know they can only claim a victory when on the field and in play. These traders often stay on the field too long and accumulate losing positions. The markets are not a game where the odds of winning or losing are equal on any given day. Trading the markets is better thought of as a business that, at times should increase inventory and at times scale down.

Think of Your Trading Account as a Business

I struggled this week as I had two positions in the red that, for tax reasons, I should let go of to offset gains and the taxes that go along with those gains. These positions are not acting poorly, but they are negative, and they both are taking longer than I had hoped to pay off. Each easily allows me to immediately purchase a similar position without upsetting the IRS. But I have hesitated to sell all week.

If trading is a business, one does what is believed to net the most profit – always. I’m usually pretty good at this, but these two small positions would represent my first losses of the year in my trading account (hurray for me). I was fortunate enough to spot the market’s relentless one-direction trend in 2022, this allowed me to ride the downward waves. The trend seems to be continuing, so exiting these two holdings and getting back into something with similar attributes makes solid business management sense. But it isn’t that easy, I’m a competitive person. The “sportsman” side of me did not want to take any losses after dozens of wins. Today, the last day of the year, I woke and told myself the intelligent thing is doing what should net more money – not what will net bragging rights over win percentage.   

There are many other reasons people don’t sell when the probabilities indicate they should. One is not pre-determining if the trade is behaving as expected; another is falling in love with a stock and not wanting to part with it. Another is knowing you were once up and not wanting to permanently lock in something that is now red. Another may be “addiction to the game,” this burns money; a good trader should be comfortable sitting with a large cash position for weeks or months if that is what makes the most business sense.

All of these feelings that impact behavior are part of being human. There are plenty of other outlets to act on feelings outside of the markets, but investing requires you to act as though you are running a business. Don’t fall in love with your positions, and if they aren’t treating you well, get rid of them.

 Car Lot Owner Mentality

This may not work for everyone, but I think of my trading account (not retirement savings) as a used car lot. I am the manager and every one of the cars represents something I want to sell. If you look at your account in this way, stocks are just inventory. If times are good and prices are rising on my inventory, I want to slow down the pace of my selling. When times ahead look as though people may not want the kind of inventory on my lot, I can’t sell fast enough, even if at a loss. The cash then raised serves as dry powder that stands ready to be invested in cars/inventory/stocks believed to be more in demand. Inventory that will provide more of a profit.

By thinking of my account as a car lot,  I avoid 95% of the mental, “acting with the heart” trading missteps that I see others get trapped by. I still have a 5% problem that includes wanting a perfect score.

Investors buying and selling on an exchange have a huge advantage over managers of a car lot. For most exchange traded securities, finding someone to close out your position with does not require someone walking in off the street that just happens to want what is on your lot. Investors of securities have sell buttons that alert the investment community that you are unloading. Even thinly traded securities will have someone take the other side of the trade at the right price. There are no other businesses in the world where unwanted inventory is this easy to unload. Traders are like car lot owners with this unique advantage.

Don’t Coddle the HODL Model

While buy and hold may be a good long-term portfolio strategy for retirement money or other long-term assets, holding without reason other than the investment community encourages you to “HODL” forever and not to throw in the towel can get you in trouble. The HODL community encourages investors of certain assets to Hold On for Dear Life; this isn’t trading; it’s a recipe for an ulcer.

When does it make sense to close out a position? In general, there are some marketplace related reasons to unwind a position. These are reasons that are related to the company, changes in the markets, or better opportunity elsewhere. Or non-market-related outside reasons. Perhaps one wishes to use some of the profit to put in a pool, or they wish to stem possible losses while waiting for better clarity. Outsiders encouraging an entire community to hold a position to help push up its price only works until greed kicks in and those sworn to HODL realize the stock is up for unnatural reasons and they should be among the first out.

Kneejerk market reactions to news or events can cause a wave of selling or buying that then settles down and reverses somewhat. This may provide an opportunity to unwind positions into the feeding frenzy and re-enter it when the market settles in at a more level-headed price.

Broaden Investment Base

If you are a used car lot owner during a recession, you may opt to only half-fill your lot and make sure the cars in inventory are affordable to the community you serve. If the economy fires up and money is then widely available, you may want to maximize your inventory and make sure they are cars that will net the  most profit. It is important to know a lot about different classes of cars. This is how you run that business, minivans and crossovers some years, even if you like British sports cars.

For trading, after the pandemic plunge in early 2020, the markets had solid trends. First up with many sectors outpacing the others. Then it trended down, with many sectors outpacing the others. Understanding the sectors and companies within the sectors allows better decisions. If you have spent all your time wondering whether you should get into Apple or Tesla at the exclusion of others, while oil companies or utilities were what had a clear trend, or in Nasdaq 100 stocks because the media always talks about them, when small-caps were making their move, you may wish to broaden your focus.

Take-Away

Internal trouble exiting positions impacts more self-directed investors than will ever admit to it on social media (or actual in-the-flesh interaction). If thought of as inventory and a tool for maximizing return, the trouble is put in a place most can handle, as a “business owner,” you are buying what you feel you can sell. That is the only reason to buy. If you don’t know if you can sell it higher tomorrow, but there is something that you believe you can, then perhaps it is time to evaluate dumping, even at a loss, to pick up something else.

Cash can often be that something else. Earning 4% annually on a short t-bill isn’t sexy, but having that liquid holding when opportunity presents itself, allows you to pounce. There is nothing worse than seeing something very clearly as a winning trade and not having the capital to load up on it.

Paul Hoffman

Managing Editor, Channelchek