Normally, You Should Not Hold Losers
Stockscores.com Perspectives for the week ending February 2, 2007
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In this week's issue:
Losses are a fact of investing life. I have never known an investor who is always right and all investors need to accept that trading stocks is a simple probability game. It is how the investor deals with losses that separate the profitable winners from the frustrated losers.
Most investors are normal people. They avoid hitting themselves on the head with a hammer. They shy away from smashing their car in to walls. They want to avoid taking losses in the stock market. As a normal person, you avoid pain.
Normal people also pursue pleasure, as investors they strive to make money in the stock market. When faced with a winner they are often quick to sell, locking in the profit and congratulating themselves for a job well done. They will justify their decision to sell with a cliché like "You never go broke making a profit" or "Bulls and bears make money, pigs get slaughtered."
Normal people do not beat the stock market.
Being normal leads you in to a costly spiral of emotions. You buy a stock, often with great aspirations of easy money and watch it carefully, waiting for the stock to realize the upward mobility that your analysis has promised. But then, something goes wrong and the stock starts to go lower. Perhaps you look at the pull back as an opportunity to buy more.
The stock then breaks through a support price that has held up for some time. The signal to sell the stock and take the loss, the proof that your decision to enter the stock was misguided, is ignored. It is too painful to sell the stock at a loss and the investor does some self talk to convince himself that things will turn around and the stock is not really a loser until you sell it.
It is at this point that the investor starts to ignore their investment. It is too painful to look at it on a regular basis, doing so brings anxiety. It is better to hope for a turnaround and maintain patience. But there will come a time when the pain and anxiety are too much to handle, the stock has fallen so much and the fear and anxiety so great that all the trader wants to do is end the suffering. It is at this extreme point that the investor exits the position for a much bigger loss than they ever expected. The sale brings relief and the resolve to never let such a loss happen again.
What does the disciplined investor do? The investor that can consistently beat the stock market has a different outlook on pain and pleasure. They find relief and gratification in taking the loss when the market proves them wrong. They don't add to losing positions. They visualize the pain of holding a loser, the suffering that comes with lacking trading discipline. When the stock hits the point where the market has proven them wrong they exit and take the small loss.
When they own a winner, they practice the patience that the rookie investor applies to losers. They hold until there is a clear signal that the stock is ending its upward trend and is likely to give back the gains. They sell when the market tells them to, not when their emotions suggest an exit.
Emotional control, the reprogramming of your mind, is the hardest thing for an investor to learn. That is why so many people fail in their quest to beat the stock market. To invest well you must achieve emotional mastery. Good strategies and tools are important to making money, but they are all for not if you can't use them as they were intended.
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Stocks go up in price because investors are willing to pay more. Investors tend to buy companies that they are optimistic about, so it is important to measure whether investors are generally optimistic or pessimistic about a company. Stock charts can provide many clues about the mood of the market. For example, rising bottoms on a stock chart indicate greater enthusiasm among buyers than sellers.
The Sentiment Stockscore considers these kinds of chart pattern factors, and provides an indication of whether investors are showing optimism or pessimism. I have found that stocks that have a Sentiment Stockscore moving through 60 and rising tend to continue to rise as investor optimism carries them along.
The Sentiment Crossover Market Scan seeks stocks that have their Sentiment Stockscore crossing in to the 60 and greater zone after a lengthy period below 60. If this occurs, and the stock does not have significant overhead resistance, then there is a good potential for a future uptrend. By limiting downside potential with a stop loss point just below a short term support price, investors can better manage risk while leaving the potential for price gains.
This strategy is good for identifying longer term trades that do not require constant monitoring. The criteria are relatively simple, and a regular check of positions for an exit signal may only take a few minutes.
I ran this Market Scan on the Toronto Stock Exchange, limiting my results to stocks that had made at least 100 trades a day. The scan found 15 stocks, of which I like two. This strategy tends to have a lower success rate but a higher risk reward ratio, meaning that the profits of being right should be quite a bit higher than the losses when wrong.
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1. T.UTS
The sellers have been in control of T.UTS for about 10 months but the down trend is losing its momentum and the stock is flirting with its downward trend line. I think this stock has good potential to start to move higher from here but it is important to limit losses if the stock closes below support at $3.70.
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2. T.CWM.UN
T.CWM.UN is a trust unit with a historical yield of better than 12% (at current prices) that also looks like it might start to go higher as it is breaking from a pennant and breaking the downward trend line. Lots of overhead resistance to work through but so long as the stock can hold above support at $7.30 it has good potential.
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References
Get the Stockscore on any of over 20,000 North American stocks.
Background on the theories used by Stockscores.
Strategies that can help you find new opportunities.
Scan the market using extensive filter criteria.
Build a portfolio of stocks and view a slide show of their charts.
See which sectors are leading the market, and their components.
Disclaimer
This is not an investment advisory, and should not be used to make
investment decisions. Information in Stockscores Perspectives is often
opinionated and should be considered for information purposes only. No
stock exchange anywhere has approved or disapproved of the information
contained herein. There is no express or implied solicitation to buy or
sell securities. The writers and editors of Perspectives may have positions
in the stocks discussed above and may trade in the stocks mentioned. Don't
consider buying or selling any stock without conducting your own due diligence.
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