As investors, we never want to see a trade lose value. The most obvious reason is because no one likes to lose money. Watching a position you purchased fall 10 percent or more in just a couple of weeks is never a good feeling, and depending on the size of the position, the loss can quickly go from annoyance to a serious problem.
The second reason why a losing trade hurts goes beyond the financial impact of a losing trade, and moves into a psychological loss. Trades can often become “gun shy”, not trusting their own research and trading instincts. This can create a ripple effect that leads to unnecessary losses, and money left on the table.
Perhaps the most important lesson in investing is that investing is a life-long adventure. You have to take a long-term view on investing, and not let any one particular trade break your confidence. That is not to say you should not review all losing trades and try to learn from any mistake you can spot, but you have to keep your confidence, and have a plan in place for when positions turn against you.
There are two basic approaches to losing trades. Some investors prefer to have stop-losses set up on all their positions in order to limit their downside risk. This approach will avoid major losses, but it prevents investors from making back losses if and when the security rebounds.
A second approach is to use dollar-cost averaging on losing trades. For example, when a position drops 10 percent, you can purchase more shares, which will lower your average cost basis on the security. As a result, the security needs to rebound less before you are able to get back to a profit on that position.
Of course, this means that you have to throw good money after bad, but if you are confident in your original research, and still believe in the stock, using downturns to average down your cost basis can be a powerful tool that allows you to turn a much bigger profit in the long run. Simply put… if you believed in a stock at $30, then you should still believe in the stock at $25.
The following five stocks appear to be great candidates for this strategy.