When a “Bad Sale” Is A Great Move

One of the most challenging aspects of trading and investing for folks to wrap their heads around is dealing with a loss.

Instinctually, we are wired to try to avoid loss at all costs. A "loss" feels like death to us biologically, and any loss can result in our body's chemical wiring kicking in to try to have us prevent it or avoid it.

A couple of weeks ago – after the passing of legendary economist Daniel Kahneman – we spoke about this concept of "loss aversion." You can read that issue here.

Despite our biological aversion to loss, the fact of investing is that sometimes we are going to lose. There are no "sure things".

Instead, we look to make bets where the probability is in our favor.

We often use the game of blackjack as an example of understanding probabilities and how to manage your exposure.

The powerful example from that game is that even when you have a "20" against the dealer – you can still lose. It can be a high-probability bet on your behalf, but it still comes up badly.

Once you accept this as a fact of investing, you must focus on developing a PLAN.

This brings up one of our essential mottos – "Plan the Trade and Trade the Plan."

It sounds easy, but it is pretty hard to do in the real world. 

At HX Research, we are here to help you do both. Come up with a sound plan for your trading and investing, and then we will give you our insight on when to enact that plan.

We have been thinking about this topic over the last weeks for several reasons.

First, on our recently launched Instagram account (you can follow us here), we shared this quote from famed trader Mark Minervini (Twitter @markminervini) …

This is a simple piece of advice that can change your investment outcome. Still, again, it's challenging to get through your psychology.

The second reason we thought of it is the recent pullback in the stock market. 

Unfortunately, we were hit with a series of events in one of our HX Trader positions that forced us to institute our "stop loss" methodology for the first time at HX Research.

We won't run through the complete analysis of the position here (that is for our paid subscribers), but we had put a position in a situation we had seen many times before. The situation had clear risks, and the magnitude (like almost all risks) was impossible to know.

Across three decades of trading, though, we had seen similar situations several dozen times. 

Our hit rate on making a profit in those situations was exceptionally high. Probably more than 90%.

Accordingly, we put the position on for a couple of weeks. We knew there was a chance it might not work out, but we thought we were sitting on a "19" against the dealer.

Unfortunately, a well-respected short research firm released a negative report on the company. They also put it out as the stock market was getting hit hard by a higher-than-expected inflation report.

We read the report and thought many of the points had merit but not materiality.

What does that mean?

It means that many things they said were potentially (or likely) true. Still, ultimately, we don't think they would adversely impact the company's operations. Our analysis is based on covering this industry for 25+ years and having seen similar situations.

The problem is that – while it may not have a material impact on the company's operations – it very well could have a material impact on the stock.

Especially as this company is in the financial services sector, and the inherent leverage in those companies can create a cascading downward spiral.

Considering all this, we think selling the stock was potentially a "bad sale ."We believe it is highly probable that looking out a few months or a year, the stock is higher and probably much higher.

In this sense, selling the position is a "bad sale."

From the standpoint of our strategy? It is a GREAT move.

We have a stop-loss methodology for that product, and we are sticking with it.

It is irrelevant whether it is an excellent buy at these levels with a different type of strategy. We take the loss and move on.

This is why that strategy works so well!

The additional benefit is that now that it is off the books, we don't spend more time thinking about it. It doesn't weigh us down psychologically.

While you might be bummed out that the dealer beat you on your "20", your only choice is to move on to the next hand and make the right move with that one.

That is what we do…"Plan the Trade and Trade the Plan”!