Page 371 - How to Make Money in Stocks Trilogy

246 BE SMART FROM THE START

stock or add money to your account to cover the lost equity in a falling
stock), don’t throw good money after bad. Sell some stock, and recognize
what the market and your margin clerk are trying to tell you.

Cutting Losses Is Like Buying an Insurance Policy

This policy of limiting losses is similar to paying small insurance premiums.
You’re reducing your risk to precisely the level you’re comfortable with. Yes,
the stock you sell will often turn right around and go back up. And yes, this
can be frustrating. But when this happens, don’t ever conclude you were
wrong to sell it. That exceedingly dangerous thinking will eventually get you
into serious trouble.
Think about it this way: If you bought insurance on your car last year and
you didn’t have an accident, was your money wasted? Will you buy the same
insurance this year? Of course you will! Did you take out fire insurance on
your home or your business? If your home or business hasn’t burned down,
are you upset because you feel you made a bad financial decision? No. You
don’t buy fire insurance because you know your house is going to burn
down. You buy insurance just in case, to protect yourself against the remote
possibility of a serious loss.
It’s exactly the same for the winning investor who cuts all losses quickly.
It’s the only way to protect against the possible or probable chance of a
much larger loss from which it may not be possible to recover.
If you hesitate and allow a loss to increase to 20%, you will need a 25%
gain just to break even. Wait longer until the stock is down 25%, and you’ll
have to make 33% to get even. Wait still longer until the loss is 33%, and
you’ll have to make 50% to get back to the starting gate. The longer you
wait, the more the math works against you, so don’t vacillate. Move imme-
diately to cut out possible bad decisions. Develop the strict discipline to act
and to always follow your selling rules.
Some people have gone so far as to let losing stocks damage their health. In
this situation, it’s best to sell and stop worrying. I know a stockbroker who in
1961 bought Brunswick at $60 on the way down in price. It had been the mar-
ket’s super leader since 1957, increasing more than 20 times. When it
dropped to $50, he bought more, and when it dropped to $40, he added again.
When it dropped to $30, he dropped dead on the golf course.
History and human nature keep relentlessly repeating themselves in the
stock market. In the fall of 2000, many investors made the identical mistake:
they bought the prior bull market’s leader, Cisco Systems, on the way down
at $70, $60, $50, and lower, after it had topped at $87. Seven months later it
had sunk to $13, an 80% decline for those who bought at $70. The moral of