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I’m a great loser. Before I explain just how good I am at it — and why you should work at it, too — you need to know two things about me:
First, I’m a day trader. Much of the investing world values the long-term “buy and hold” strategy. Warren Buffett is the most famous example, and he’s done well. In contrast, the very definition of day trading is that you cannot hold any positions overnight. In my case, I rarely hold trades for even hours. My average hold time over my last 20,000 trades has been about five minutes.
The second thing to know is I’ve built both my day trading account and my information business by self-funding them. Much of the business world values leverage. It’s the notion that if you really believe in your business, you should take on debt or get equity partners. “You’re either growing or you’re dying!”
Being a day trader and a self-funded business owner have combined to make me really good at cutting my losses. Here are four principles for cutting losses that may be useful to you, even if you have no intention of day trading.
1. Don’t waste your latitude just because you have it
Currently, I could afford to lose six figures in a trade, but instead, I still trade the same way I did when my back was against the wall.
For a little backstory, I lost a lot of money day trading until I was close to broke: I was divorced, living with my dog in Vermont, selling my furniture on Craigslist and chopping wood instead of paying for heat. In that crucible, I identified what my previous winning trades looked like and one other thing: that I was holding my losers too long. I had to cut my losses faster if I would survive.
This is painful to do! Walking away not only removes the hope that the situation may turn around, but it goes against what we’ve all been told: “Stick with it! Don’t be a quitter! Finish the job!”
Let’s say your situation is different: you have enough money that you can stick with a difficult situation for a while. Should you?
I don’t know your situation, but I do know this: making the decision to quit is doubly hard when you’re in the thick of it. The best way to decide is to identify your quitting criteria upfront. In day-trading lingo, it’s your “max loss.” You are insane to take a position in a stock without knowing the point at which you absolutely must sell. That way, you don’t need to think or evaluate if that number is reached — you simply must react. If you know those criteria with the business venture you’re involved in, it will be far easier to minimize the pain if things suddenly go south for you.
2. Don’t let sunk costs hijack your larger perspective.
A “sunk cost” is what you’ve already spent on a project at the point when you start to think about abandoning it. Examples might be a half-built nuclear reactor, a Pentagon project wallowing in budget over-runs — or the project that’s become a boat anchor to your business.
You might already have spent a lot on that project, and writing it off may be painful and embarrassing, especially if only recently you were on record as optimistic. The only thing worse would be to throw even more good money after bad. You need to be willing to cut your losses.
Here’s how it happened to me. Day traders can — and should — use a trading simulator to develop and test their trading skills without risking real money. It’s a crucial piece of software, so we decided to buy some source code to form the basis of our proprietary simulator. We customized it, and it worked quite well.
Only it didn’t scale. The first 50 to 100 users liked it, but the system began to show signs of choking with hundreds of users. I had invested six figures in buying and modifying the code. Could we have rebuilt it from the ground up? Yes. But the prospect of turning it around was too far distant. I threw it away and entered a partnership with a company that specialized in simulation software. That hurt, but it was the right move.
3. Encourage feedback, but don’t let it have outsize influence on hard decisions
Business owners want engaged employees who feel their opinions are being listened to. Sometimes, that means doing the opposite when it’s in the company’s best interest.
There have been times when I had gut intuitions about what we needed to do, and my team was like: “This is way too much! How are we even going to explain this when people write in?” In these cases, I tell them: “I have confidence that you’re going to figure it out.” My job is to solve what will work long term, and other team members must solve the challenges in their areas.
4. Protracted losses have compound effects
When you don’t cut your losses quickly, that’s an opportunity cost: you’ve spent time managing the loser when you could have redirected that time and money to other opportunities. But an extended loss has another downside: it shakes your confidence for weeks or even longer. In contrast, a quick decision to cut a loss can be a confidence builder.
Making decisions is like exercising a muscle. Some decisions are easy, like where to eat. But when faced with a tough one involving losses, consider using that muscle, feeling the pain, and doing it anyway. You’ll be that much stronger.