What if the stock rises after cutting loss? I already feel stupid for buying that stock at a lousy price. Now I feel even more stupid to sell the stock at a lousier price.
What if I don’t cut loss now and if falls further? Now I feel stupid not to sell earlier. Do I cut further losses immediately then or wait for recovery? Either way there is risk of feeling even more stupid if things do not go my way and I cut my loss anyway.
Is it possible NOT to feel this way?
Investors that face such dilemmas often only have an entry strategy (ie to buy stock) but no exit strategy (ie to sell for profit or cut loss).
One of the maxims in value investing is that you only exit when you make money. In value investing, you NEVER cut losses. You buy more when your stock drops. The rationale is simple from the illustration below.
Assume you believe Singpost is a value stock (like me).
It has long operating history, high profit margins, consistent dividend payout history and policy, high ROE and low debt. It is currently trading at below historical PE.
If you are willing to buy 10 lots of Singpost at $1.10, when Singpost dips 10% to $0.99, you should buy at least the same number of lots or even more. This is because for the same amount of price I spend on Singpost originally, I can now buy more with less money. I will collect more dividends with the same amount invested and at the same time, dollar cost average my investment.
Assuming I bought another 10 lots at $0.99, my average cost will be $1.045/lot. Singpost only need to rebound 5.6% from $0.99 to breakeven. It will take Singpost to rebound more than 11% from $0.99 for me to breakeven at $1.10.
You must believe in the companies you have initially invested in. Do not lose faith just because others have bought and sold it at a different price you had bought. The price changes all the time, not the fundamentals. Hence, do your homework thoroughly before you take the plunge and only invest in companies you believe in.
Then, you will never need to cut loss. You will be happy to buy more.