Cutting Losses Is like Buying an Insurance Policy

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Cutting Losses Is like Buying an Insurance Policy

This policy of limiting losses is similar to paying insurance premiums. You reduce your risk to exactly the amount you are willing to take. Granted, many, many times the stock you sell will immediately turn around and go up. You will probably get very perturbed and think you made the wrong decision if the stock afterwards rebounds in price.

If you bought insurance on your car last year and didn't have an accident,did you waste your money? Are you going to buy the same insurance  this year? Of course you are!
Did you buy fire insurance on your home or business last year? If your home did not burn down last year, are you upset because you made a bad financial decision? You don't buy fire insurance because you know your house is going to burn down. You buy insurance just in case, to protect you from the remote possibility of a serious loss. It is the same for the winning investor who cuts losses quickly and closely; he or she wants to protect against the possible chance of a larger potentially devastating loss from
which it may not be possible to recover.

Some people have even damaged their health agonizing over declining stocks they were holding. In this situation, it is best to sell and stop worrying.

I know a stockbroker who bought Brunswick in 1961 at $60. When it dropped to $50, he bought more, and when it dropped to $40, he added again. When it dropped to $30, he dropped dead on the golf course. Never argue with the market—your health and peace of mind are always more important than any stock!

Small losses are cheap insurance and the only kind of insurance you can buy on your investments. Even if a number of the stocks move up after you sell, which many of them surely will, you have accomplished your critical objective of keeping all your losses small. And you still have your money to try again for a winner in another stock.

If you can keep the average of all your mistakes and losses to 5% or 6%, you will be like the professional football team that opponents can never score yardage on. If you don't give up many first downs, how can they ever beat you?