Strategic Stock Trading: Master Personal Finance Using Wallstreetwindow Stock Investing Strategies With Stock Market Technical Analysis by Swanson Michael

Author:Swanson, Michael [Swanson, Michael]
Language: eng
Format: epub
Published: 2012-04-30T05:00:00+00:00

Chapter 9: Manage Your Risk

Imagine this scenario. You are the CEO of a giant airline company. You have invested $100 million of the company’s money into a research project, the purpose of which is to build an airplane that cannot be detected by conventional radar. When the plane is 90% completed, a competitor begins marketing a plane that cannot be detected by any radar. It also is much faster and far more economical than the plane your company is building. Do you invest the final remaining 10% of your research funds to finish your plane?

If you answered yes, than you have made a big mistake. You have literally thrown good money down what has now become an investment trap. Don’t feel bad if you did say yes, because the economists who created this survey found that 85% of the people who answered it said they would, too. However, when they changed the question so that it did not mention any prior investments, only 17% said they would keep spending money on the project.[1]

From a purely financial standpoint, there is no logical reason to spend the remaining $10 million, because the airplane is going to be useless in the face of your competitor’s plane. The research project is now a waste of money. The commitment already made to the project, though, prevents most people from walking away from it, even though that is the right thing to do.

What is really at issue is not the money, but the feelings people have about making mistakes and taking losses. If they walk away from the project, they may feel that they have lost $90 million on it or, at the very least, have made a mistake. By continuing the project, they escape from these feelings of loss or disappointment by putting them off. They may also fool others and themselves into believing that everything is fine.

This type of behavior is natural to people and can cause them to lose fortunes in the stock market. There is an old adage that you make money trading by letting winners run and cutting losers, but most people have a very difficult time doing this. In fact, they tend to do the opposite by holding on to losing positions until they get so upset that they cannot take the losses anymore and then selling them while they cut their winning positions short to make up for their losing trades and in fear that they will become losers, too.

When people make an investment, they make a commitment and they buy into an idea that it will make them money. It is as if they bought a lottery ticket that they never rub the numbers off of. As long as they don’t look to see whether their ticket is a winner or loser, they can fantasize about the money it might make them.

Most people treat the stock market like this. If they buy into a stock and it drops, they don’t get out because they fear that if they sell out at a loss, they will feel like a loser.

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