Contrarian Investing and Stop Losses and Separating Emotions From Reason
Picture yourself in the following scenario. Your emotions are stirring because you found a stock that is down substantially and appears to be a sensational value. You do the research, which confirms the value, and your mind runs with excitement that you have found a gem. You can see visions of large returns and decide to allocate a large amount of capital to buy the stock. The fact that the stock is making lower lows in terms of price is of no concern. You have confidence in the fundamentals because you’re a value investor. You were taught that fundamentals are more important than technicals, which are just random, price movements of the stock that have no interpretive value. Also the stock is down dramatically, how much lower can it go.
The thought of not buying the stock and watching it pop up 20 to 50% in a few weeks without you is just too hard to bear so you buy.
A few weeks or months later the stock starts falling 10 20 30% and the previous emotions of excitement turn to despair. On the surface you still appear confident to yourself and clients with your ego telling you to suck it up and trust your analysis. However, deep down you know you are either very early or just plain wrong. In either case you’re in a value trap with no idea if the share price decline is a true signal that significant fundamental problems are about to appear.
This is a scenario that happens over and over to contrarian investors. It was especially acute in 2015 and now 2016 as value investors got massacred investing in resource related equities that started out as deep value stocks. It’s easy for just a few bad stocks to destroy not only the year but also multiple years. This is the reason I created turnaround stock investing.com , to help contrarian investors balance reason with emotion. To allow investors to be surrounded by other contrarian investors who are attempting to learn how to manage a portfolio and let go of the ego telling them to double and triple down on a falling stock.
I challenge any investor to show me more than a handful of investors who survived over multiple decades investing in stocks that did not have stop losses on positions or follow a very strict money management discipline in conclusion
Right now contrarian investors are finding what appear to be extreme opportunities based on fundamentals in many small-cap stocks. However, the price action in most cases is horrible as the stocks continue to make lower lows. Don’t dismiss the signal of lower lows, which may mean that fundamentals are rapidly deteriorating. Without confirmation of a classical technical bottom signal you are standing on one leg.
To an inexperienced contrarian investor the strategy of waiting for both the technical and the fundamentals to lineup takes extreme discipline over your ego and emotions. It’s easy to cast aside the technicals when the fundamentals maybe screaming at you to buy.
It’s even harder to cut losses because most value investors have been taught to buy more shares as the stock price goes lower. However, don’t lose sight that value investing is investing in companies whose cash flow’s are in a downturn. It is extremely difficult to not only know when this downtrend will end but how far cash flows may fall. As a result it’s easy for a great value stock to turn into a scenario where the stock never returns to your purchase price.
Turnaround stock investing.com teaches investors to be professionals not amateurs. To be a professional simply means to have a plan in place before you buy stock. You want to know where you will stop out and under what scenario you will add more to your position. It’s critical to make this decision before your purchase shares not when you are highly emotional from a declining stock price.
Due to the vast amount of information on the Internet, security analysis and technical analysis are now the easy part of investing. The hard part for Contrarians is to look in the mirror and admit that a declining stock price may be sending you a signal that your fundamental analysis may be wrong and pay attention. There is wisdom of crowds at critical turning points. Being a contrarian at the wrong time can lead to a financial wipe out. Realize that buying more of a stock as it declines and not exhibiting caution is the act of an amateur not a professional.
As Mike Tyson says every one has a plan till they get punched in the mouth. Have a plan in place when your portfolio or stocks start to fall dramatically. Realize that 20% of your stock picks will generate 80% of your profits and don’t feel bad about taking losses. It’s part of the game of being a successful contrarian investor.
