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How to Manage a Losing Position: Explained

By Investing.com (Francesco Casarella)Market OverviewJun 24, 2023 16:00
ph.investing.com/analysis/how-to-manage-a-losing-position-explained-175438
How to Manage a Losing Position: Explained
By Investing.com (Francesco Casarella)   |  Jun 24, 2023 16:00
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  • While investing, losses are inevitable
  • That's why it is crucial to have a strategy before investing in any asset
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I have received numerous emails, particularly in late 2022 and early 2023, from investors seeking guidance on managing losses incurred due to the market decline in 2022.

Now, it is important to note that each position and situation is unique, and I must clarify that I am no longer involved in providing consulting services. However, there are several key points that every investor should understand before allocating any funds to the markets:

  1. Accepting and managing losses is an integral part of investing. Recognizing that no investor, not even Buffett, consistently generates profits is crucial. Successful investors are often distinguished by their ability to navigate challenging periods such as the ones experienced in 2001, 2008, and 2022. It is unrealistic to expect perpetual gains or positive returns at all times. Corrections and bear markets are inevitable, and comprehending this reality is essential before investing.

  2. When making investment decisions, it is imperative to thoroughly understand what is being purchased and the underlying reasons behind the purchase. Many investors, unfortunately, engage in haphazard buying without a clear strategy or rationale. Responses like "because someone told me... because I read that... because I heard people discussing it..." are insufficient. A well-defined strategy and specific motivations should support every purchase.

Returning to the initial question of handling portfolio losses, the approach largely depends on how one initially structured their investments. Let's examine a few scenarios together:

  • Losses incurred on ETFs/diversified funds
  • Losses incurred on individual stocks
  • Losses incurred on individual certificates
  • Losses incurred on individual bonds

Losses on ETFs

Considering the logic behind the purchase and the percentage of the total portfolio allocated to the ETF is essential. If the investment is strategically positioned as part of the equity portion of the portfolio (e.g., S&P 500, Nasdaq, iShares MSCI World ETF (NYSE:URTH), Euro Stoxx 50), two options may be considered: either adding to the position during declines (if aligned with the overall strategy) or patiently awaiting a recovery. However, both scenarios assume an initial investment horizon of at least 8-10 years and an understanding that markets can experience downturns.

Losses on Individual Stocks

Assess the weight assigned to each individual stock in the portfolio and the analysis conducted on those stocks. Was the purchase based on equity strength, earnings, or future growth? Did you establish a target price and a buying strategy? These questions should have been addressed before investing. Let's say a stock is down 50 percent, but it represents only 2 percent of the portfolio (due to proper diversification).

The impact on the overall portfolio would be just 1 percent, which is manageable. However, if you mistakenly allocated 50 percent of your capital to that single stock, the impact would be a significant 25 percent loss on the total portfolio. In such cases, it becomes crucial to consider the following:

If, during a situation, you find yourself asking, "What do I do now?" you're doing it wrong.

Indeed, let's consider a scenario where you are experiencing a 30 percent loss on a stock. However, if this decline is consistent with the performance of the sector and the broader market, it is advisable to conduct a fresh evaluation of the stock. Assess its fundamental aspects to determine if it still exhibits positive characteristics. You may not need to change your position if the stock remains fundamentally strong. You might even consider increasing your investment in the stock.

Regarding money management, one crucial consideration is determining the initial position size for each stock and understanding the reasons behind it. Why did you choose to allocate a specific amount to a particular stock? It's essential to have a clear strategy in mind.

If you tend to rely more on technical analysis, you might also use stop losses to manage your risk. Ideally, you would have already set these levels when entering a trade. However, evaluating the market conditions before implementing stop losses is crucial. In 2022, for example, using stop losses without considering the overall market situation would have resulted in substantial losses.

Losses on Certificates

Regarding certificates, it's important to evaluate the quality of the underlying assets. Additionally, consider the expiration date of the certificate. Many investors make the mistake of holding onto losing positions hoping for a recovery, only to end up with even greater losses.

In such cases, it's often wiser to close the position early, accept the loss (which can be used as an offsetting capital loss for the next four years), and potentially reposition yourself in similar instruments with better strikes and coupon yields that can help you recover from the previous loss. On the other hand, if the certificate is well above the barrier and the underlying assets are of high quality, you may choose to wait patiently.

Losses on Single Bonds

Turning to single bonds, the duration of the bonds you purchase is a critical factor. Buying 40- or 50-year bonds before 2022 to capture a slightly higher coupon rate reflects a lack of understanding about how investing works. If these bonds were recommended by your advisor, it might be wise to consider changing advisors.

As it unfolded, the risk was the sharp rise in interest rates, and the longer the bond duration, the greater the loss. However, if you invested in 5- or 10-year bonds, you might be able to hold them until maturity and receive repayment at par. But if you specifically invested in long-duration bonds, your children or grandchildren will likely end up holding them until maturity. Otherwise, your only option will be to recover a small amount at some point and sell the bonds at a loss.

Conclusion

The key is to actively understand what you are investing in and develop a strategy beforehand and throughout the investment process. This ensures that you never find yourself unprepared and are equipped to handle any situation.

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Disclaimer: This article is written for informational purposes only; it does not constitute a solicitation, offer, advice, counseling, or recommendation to invest. As such, it is not intended to incentivize the purchase of assets in any way. As a reminder, any asset is evaluated from multiple points of view and is highly risky therefore, any investment decision and the associated risk remain with the investor. The author does not own the stocks mentioned in the analysis.

How to Manage a Losing Position: Explained
 

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How to Manage a Losing Position: Explained

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