Dealing With Losses

Unfortunately most investors in general and energy investors in particular are probably looking at some pretty alarming losses in their portfolios after the events of the last few weeks. Over time your performance as a trader or an investor doesn't depend on whether you have any losses, as some positions going against you is one of the few certain things in a trader's world. What counts in the long run is how you deal with them when they come.

Understanding that not all investments will work out is the first step in dealing with adversity. If you know that sometimes even your best, most well researched and logical ideas will be wrong, then you are less likely to make the situation worse when the inevitable happens. That is why I bang on so much about identifying a stop loss level at the time you initiate a position.

In times of normal volatility it can be frustrating to cut yourself out of a position only to see the market reverse and edge back towards your breakeven point, but at times like this having at least some of your positions hit their stops is of enormous benefit. Not only does it reduce the actual loss but it also changes your state of mind. You feel that your discipline was smart and that you have some cash to take advantage of any further falls. Your focus, therefore, shifts and you begin to look for a bottom to the move rather than worrying that there might not be one.

The key is to avoid turning a setback into a disaster, and much of that is about controlling the level of panic that you feel. Logically we all know that the market is coming back at some point and that with hindsight the current drop is more likely to look like a good buying opportunity than anything, yet our instinct when every day brings more selling is to join the herd and sell everything. In these situations it can help to play a few mind games with yourself. The knowledge that it could be worse and that at least you have done something is reassuring and helps you to make rational decisions. Rationally, selling out after a big drop makes no sense. The idea is to buy low and sell high, not the other way around.

If you are not a believer in stop losses and have held on until now then the pressure to bail out is probably becoming overwhelming. In that case, just staring at a screen and hoping things turn around, even if you genuinely believe they will, will not be enough. I have found over the years that taking some action in that situation helps you to think more clearly. Selling out of a couple of losing positions to free up some cash for when the bounce comes or rotating some risky plays into safer holdings such as utilities will help to calm the nerves, but, should this turn out to be the bottom, you will not have done too much damage to your prospects of recovering.

There are signs that now could actually be the worst possible time to give up on your energy portfolio. On both Wednesday and Thursday U.S. stocks followed a similar pattern. On each day futures indicated a significantly lower opening, but each time the early morning trend was reversed during the day, with energy stocks leading the recovery. This doesn't necessarily mean that we have found a bottom but it does indicate that that is a possibility and suggests that energy, as one of the hardest hit sectors, will be leading the recovery when it comes.

We all know that Warren Buffett was right in theory when he said that we should be "…greedy when others are fearful…" but that is a difficult thing to do. Understanding that losses are inevitable at some points and convincing yourself that you are not just standing idly by and taking them makes it just a little bit easier. More importantly it will stop you from making the classic retail investor's mistake and getting squeezed out just before the rally comes.