I’ve gotten into something of a pickle with this latest trading position. Just a few weeks ago it seemed that all the operational and economic stars were aligned to send this stock into the stratosphere, but things did not work out like they were supposed to. It is not a complete disaster, but there were numerous little ‘misses’ on the way. So, although the broader equity market is reaching a 52-week high, my stock is closer to its 52-week low, and I am losing money.
Thankfully, I have a good advisor in situations like these. More than just a counselor, he is a genuine friend. It is rare in this industry to have someone totally selfless on your side, someone who has only my best interests at heart. When I tell him that I believe things do not look so bad, he reminds me of the preciousness of my financial resources and the danger of poor decision-making on my long-run performance. When I try to convince him of the positive effect continued central bank activism will have on stock prices, he reminds me that future monetary policy was not one of the arguments I used to justify buying the stock in the first place. When I ask what he thinks about the idea of buying more, he starts talking to me about my own investment process and challenges me to ‘do the math’. He can be a real pain at times.
Who is this person who works so tirelessly at my side? Who is this advisor who, without asking for payment, is a constant source of constructive and objective advice? It’s me, but me sometime in the past. Before I got into this engagement, I had the foresight to make a note of why I was doing it, what I expected as an outcome, and what conditions would signal that I had made a mistake. It was important to do it at that time because the only moment I could hope to be unbiased about this engagement was before I entered into it.
That is what a stop-loss is: it is a message from my former, unbiased self to my present self. This present self, in the meantime, has incurred a loss and now wants to avoid realizing that loss at all costs. My present self is now motivated by cognitive dissonance to find good reasons for not realizing that loss, or at least a justification for having entered the engagement in the first place. My present self is as worried about losing face as about losing money.
Although it is common to think about a stop-loss as price threshold, there is no reason why it has to be. In fact, it is possible to define failure (let’s be brutal about describing the situation) in any terms we want. The key is to write it down before the initial decision is made. This is because once an engagement is entered into our perceptions change irrecoverably. Our faithful counselor is then no longer in a position to dispense any valuable advice.