By Nick Rokke, analyst, The Palm Beach Daily
For most people, it’s tough to sell a stock that’s losing money.
It’s not just about losing money, though. When you sell a stock at a loss, you’re admitting you’ve made a mistake. And that stings…
To avoid this pain, many investors hold onto their losers… After all, they think that losing position might eventually turn into a winner.
But people who hang onto their losing stocks too long can turn a small mistake into a bigger one. That’s because, even if losing positions turn around, they still underperform winning positions over time.
So, staying emotionally tied to your losers is a surefire way to wreck your portfolio.
At the Daily, our goal is to help you build wealth in a rational manner. And one of the most irrational things you can do is hang onto your investments based on your emotions.
Why People Don’t Cut Losses
Let’s be honest… Everyone—including the world’s best investors—will have some losing positions.
For example, famed investor Bill Ackman blew a $4 billion hole in his hedge fund’s portfolio when his largest position, Valeant Pharmaceuticals, tanked. The stock lost 96% of its value before Ackman sold in March 2017.
Even the smartest investors get emotionally attached to their positions. Psychologically, it’s hard for most people to cut their losses.
Daniel Kahneman won the 2002 Nobel Prize in Economics for studying this phenomenon.
Kahneman was interested in “loss-aversion” theory. In short, the theory states that people are more likely to act to avert a loss than to achieve a gain.
For example, Kahneman found that investors experienced twice as much pain from taking a $100 loss… than the amount of joy they received from winning $100.
A 1999 study published in The American Economic Review came to a similar conclusion: Investors are 50% more likely to sell a winner than a loser.
But what’s more interesting is what happens after they sell…
Why You Should Cut Your Losses and Hold Your Winners
On average, the winning stocks those investors sold went on to outperform the losers they held onto.
That’s because stocks that go up tend to continue going up.
Multiple academic studies have proven this.
A 1993 study in The Journal of Finance studied stocks from 1965 to 1989. It found that stocks that rose the prior six months outperformed over the next six months. The winners were up 12%, while the S&P averaged 10% during that span.
That’s why you hold onto winners.
And if winners outperform going forward, that means losers underperform.
For example, a 2002 University of Illinois study found that the biggest losers tend to underperform winners by as much as 1.5% per month. That’s 20% per year.
So, now you know why you should sell your losers. The next question is: When?
When to Cut Your Losses
At Palm Beach Research Group, “trailing stops” are one of our favorite ways to let us know when it’s time to cut our losses.
A trailing stop can be set at a defined percentage away from the stock’s market price. For example, if you set a 25% stop loss on a $20 stock, you sell it if its price drops to $15.
Doing this takes out all the guesswork and emotion of exiting your positions. It lets your winners run and cuts your losers short. That’s the recipe for making money in the stock market.
Now, there is no one-size-fits-all percentage for a trailing stop.
For example, you’d want to put a tighter trailing stop on a stable company like Apple or Walmart… and a wider trailing stop on volatile assets like cryptocurrencies.
If you don’t want to guess what the proper stop-loss size should be for every position in your portfolio, consider subscribing to a service called TradeStops.
TradeStops uses an algorithm that automatically sets trailing stops based on your positions’ characteristics, which can save you up to 632% on stocks you already own.
TradeStops is an automated solution to help you manage your positions… and help you extract more money from the market. Click here to learn how to start your risk-free trial.
Nick Rokke, CFA
Analyst, The Palm Beach Daily
P.S. Do you already have a couple big losers in your portfolio? Tomorrow, I’ll show you one thing you can do in the next few weeks to help recoup some of those losses.
Have stop losses saved your portfolio from disaster? Tell us your story right here.
Gold Stocks Are Ready to Play Catch-Up
By Jeff Clark, editor, Delta Report
Let’s face it… 2017 has been tough for gold stock investors.
While just about every other asset class has enjoyed strong rallies, gold stocks are barely breaking even. The NYSE Arca Gold BUGS Index (HUI), for example, closed yesterday exactly where it was on January 3, 2017.
Meanwhile, the S&P 500 is up 16%. Treasury Bonds are up 9%. High-yield bonds have rallied 10%. Emerging markets have racked up gains of more than 20%. International developed stock markets all have double-digit gains. Even oil—which spent the first six months of the year in a steep downtrend—is now trading 4% higher than where it started 2017.
You could have made money this year in just about anything besides gold stocks.
Of course, that’s not to say gold stocks didn’t have their moments to shine. The gold sector actually put on several decent intermediate-term rallies this year.
The VanEck Vectors Gold Miners ETF (GDX) has enjoyed four separate multi-week rallies—racking up gains of 16%, 15%, 12%, and 19%. But you had to be quick to take profits, because the gold sector gave up the gains just as quickly as it earned them. Just look at this chart of GDX…
The first three rallies in GDX this year gave back 100% of their gains. And a new rally got started only after the MACD indicator dropped into oversold territory and the short-term moving average crossed over the longer-term moving average line (noted with the blue circles on the chart). Those "bullish crosses" coincided with the end of the gold stock decline phases and the start of the rally phases.
The rally that peaked in early September was the strongest of the year so far for gold stocks. The decline from the peak, however, did NOT give back 100% of the gains. Instead, the chart has formed a higher low. That is bullish action.
Notice also that the MACD indicator just completed a bullish cross. And GDX appears to have broken above its downtrending resistance line.
This could be the start of a new rally phase for the gold sector.
With that in mind, traders should use any short-term weakness to add more gold stock exposure.
P.S. I just showed my Delta Report subscribers my favorite trade in the gold sector right now. It has the potential to earn 167% over the next three weeks. To find out more about it, click here…
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