The psychology of stoploss – Value Investor India
I wrote this to our subscribers recently. Hope you find it useful
Why be cautious
It is easy to swing for the fences. If we had been fully invested and had higher allocation to some positions, our returns would be higher. However, I have been a proponent of the principle – The number one goal of investing is survival.
This does not mean we won’t lose money at the position or portfolio level from time to time. Our goal is to have losses from which we can recover financially and psychologically. Most investors underestimate damage to the psyche after a huge drawdown. All high return strategies appear great in hindsight, but usually have 50%+ draw downs in them. It is easy to see such drawdowns on paper and completely different to experience it.
I am certain that less than 1% of investors can tolerate a 50%+ drawdown and continue to invest in the same manner as before. Most throw in the towel, never to return to the markets. There is no point in following an approach you cannot stick with, especially when the going gets tough
The psychology of stoploss
This is another change we introduced in the last few years to manage risk. I never used a stop loss for 20 years and found the idea contrary to buy and hold. If you plan to hold a position for the long term and it drops in price, then it surely is cheaper, and one should add more?
We have done that in the past, before we got hit by a few failures in 2018 and 2020
As I mulled over this issue, I realized that buy & hold works only as a special case – my analysis is correct and there is no change in the underlying thesis. In these failures, I got the analysis wrong, or the thesis changed. Holding onto such positions is financial suicide
We review a host of fundamental and technical factors to arrive at a stop loss number, which also depends on the type of setup. A long term buy and hold position has a much wider stop loss compared to a momentum stock
More than the number though, a stop loss acts as a line in the sand. It allows us to exit the position and look at it at a later point without any baggage.
The most important benefit for us is psychological. It has allowed me to be more aggressive with new ideas as I know that our downside is capped. In absence of a stop loss, the downside risk would have me worried, and we would often miss the idea. In other words, the idea of stop loss has been mentally liberating
Disclaimer
This report is published by RC Capital Management – SEBI Registered Investment Advisor (INA000004088).
This report is for educational purposes only and should not be construed as an Investment Advice.
RC Capital Management may have recommended the above stocks to our clients in the past. However, this is not a recommendation to buy / hold / sell the stock at the time of publishing this report.
The securities quoted are for illustration purpose only and are not recommendatory
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