When You Are Wrong
by Sunny J. Harris
No one invests correctly all the time. But what do you do when
you are wrong? Here are some thoughts about what to do when you have
a position and, for whatever reason, you start wishing you didn't.
Test the Original Thesis
When things haven't worked out like you originally planned, the
first thing to do is check your thesis, the reason why you bought
this stock in the first place.
A thesis should be an argument behind why the stock was going to
go up. It may be simple, such as "demand for semiconductors will be
rising and volume increases will not depress the price." This could
justify a purchase of semiconductor stocks.
But six months later, if the price of your stock never starts
rising, you should go back and check whether your thesis came true.
If chip prices did rise, but your stock didn't, the reasoning just
didn't work. It happens. But if chip prices never did rise, and you
now think they won't, then selling the stock is the only logical
conclusion, even if it means a loss.
"Because it is going to go up in price" is the worst possible
thesis. In fact, it isn't a thesis at all. If this is the only
reason you have for buying a stock, you are taking huge risks. Even
momentum players have some kind of technical analysis or other
identifiable reason for taking a short-term position.
If your original thesis now appears to have been wrong, sell the
stock. For example, many people purchased Y2K software stocks in
1996 on the thesis that the Y2K problem would mean millions, even
billions, in revenue for Y2K companies. After peaking in 1997, Y2K
stocks went into a general decline. The thesis of big spending was
never justified as quarter after quarter showed. Investors who
deduced early that the thesis was wrong, and sold at a loss, saved
themselves an even bigger loss later.
If your original thesis is still believable and you think it's
true, then you should hold onto the stock. In fact, the lower prices
may simply mean the stock is an even better opportunity than it once
Take the Loss
Holding onto a stock because you just don't want to take a loss
is one of the most common ways to lose even more.
We all hate to lose money. But the "I'm getting out of this dog
just as soon as I hit break-even" attitude has neither a thesis, nor
a timeframe. It is just wishful thinking.
The problem with this attitude is that you miss other
opportunities for the money tied up in the losing position. Often,
dumping the loser and finding a better investment is a faster way to
get back to "break-even."
A Hold is a Buy
Forget about how Wall Street firms grade stocks.
When Wall Street says Hold, they often really mean Sell. And when
a money manager says he/she is holding, not buying, it takes into
consideration the rest of his/her portfolio.
But for a single position, holding a stock is the same as buying
the stock, as far as the money in that stock is concerned. If you
didn't hold the stock today, would you put the same amount of money
as you have in your losing position, into the stock? If the answer
is no, why are you holding now?
The Inadvertent Long-Term Holder
All too often the following occurs: a trading position turns into
a long-term investment because the investor refused to take the
For example, you buy a stock on takeover rumors, or as part of a
momentum play, but you were wrong. The takeover rumor turned out to
be just a rumor, or you were the last guy in line at the momentum
game. In either case, you bought at the top, and the stock has been
going down ever since.
So you hold, thinking it will turn around soon. But it doesn't.
This is the worst way to take a long-term investment in a stock.
If the long- term story doesn't really grab you, what are you
holding this stock for anyway? Even worse, if you find yourself
researching the stock after you've bought it, it is harder to
be critical about what you learn. You naturally want to hear good
news, and only good news.
Learn From It
Things don't always work out. Even the best investors lose at
times. But the best investors know that and move on.
We all like to think that making money means we were smart. Maybe
even smarter than everyone else. But the truth is that sometimes
dumb investments make money, and smart investments lose money.
Just because a stock goes down doesn't mean it was a dumb
investment. All investments are risk/reward decisions, and sometimes
the risk side is what wins out. But it doesn't mean it was the wrong
bet. When that happens, selling at a loss is the smart move.
But when you do make a dumb investment, and we all usually know
it when it happens, it's usually better to undo it, even if it means
taking a loss.
We're all wrong sometimes.