Have you ever had an old car or boat and you keep it going, somehow?
Well, obviously the way to keep it going is money, and more money. And as you put more in, how do you decide when enough is enough? How do you cut your losses, get rid of it and buy a new one?
This is what the behavioural economist’s term the ‘sunk cost effect’ and I am sure every trader can relate this to an experience in their trading career.
Within trading, the impact of such a situation is potentially going to be great, as a sunk cost effect trade is one where you can’t let go of it even though it’s not going to give a return on investment.
Whether you have a big or small holding, the issue is the temptation to hold on to the losing trade that you put so many hopes into, even if you have a trading plan that says to get out. The issue is the emotional attachment to all the time invested to identifying and researching the opportunity as well as the money invested.
At what point do you cut out? How do you leave it all behind?
Accept Your Losses And Move On
Well, the answer is pretty simplistic and obvious. Accept the loss, take the set back, and move on. Not something human nature is too inclined to do but definitely something that a trader has to adapt to.
Being wrong sometimes is natural, human even. For a trader, it is a standard part of the markets as it is unrealistic to believe you can control them enough to win with every single trade, no matter how much of an expert you are.
It is the other side of the probability odds that you are relying on and that also dictates that you acknowledge you were wrong and get out gracefully. The biggest issue is that the cost of staying in can mount up without even noticing it, in part because the money committed to that losing trade can’t be used elsewhere in the meantime.
So where do you start?
Well go back to the basics and acknowledge that you are bound to make mistakes as a trader. It’s about giving yourself permission to be wrong, even embrace it as it is a mark of being a ‘real’ trader where you set outside the basic investor, safe ground into active trading and risk.
The key is that you don’t need to explain yourself or justify your actions as you are only responsible to yourself. This is where it is easy to try to avoid appearing fallible but the successful trader is the one who accepts they will make mistakes and that they are not required to make such justifications or set such standards like error-free trading. They take the setback and focus on the next opportunity.
Losses will happen, errors will be made and decisions will appear to be hard to justify but that is the nature of the job. It is what you do about it all that is the mark of the seasoned versus novice trader.
Acknowledge when you are hanging on to a trade due to the sunk cost effect.
Recognise the opportunities you are missing out simply due to pride or annoyance at picking the wrong stock and let it go.