When an investment goes against you, there are two paths to choose from...
You can cut your losses, or you can dig in and double down.
The first option might feel like admitting failure. Worse, you might feel like you're giving up on an opportunity where you once had serious conviction.
On the other hand, digging in and doubling down feeds your ego. You tell yourself the market is wrong and you're right. You become the hero of your own story. And if your bet pays off, the vindication is sweet.
It's so tempting, even investment professionals tend to double down at the wrong times. And they're doing it right now.
The pros are making the most aggressive bets against stocks we've seen since 2011... even though the market is moving higher. But based on history, that means the current rally should continue.
Let me explain...
It isn't easy to cut your losses. But there sure are benefits.
Moving on means a small loss can never grow into a big one. And just as important, selling your losers will free up your mental capacity, letting you focus on the rest of your investments.
That's why we always recommend using stop losses to take the emotion out of selling. But right now, investment professionals are taking a different approach.
It started with a crazy situation in the futures market a little more than a month ago. As I wrote then, traders were betting against stocks en masse.
The Commitment of Traders ("COT") report showed the details. This is a weekly report that tracks what futures traders are doing with their money. Specifically, we looked at the COT for the E-Mini S&P 500 Index...
The E-Mini contracts are just smaller versions of the typical S&P 500 contracts. The important part is that these are futures contracts – so mom-and-pop investors aren't the ones trading them. We're looking at hedge funds and other sophisticated professionals.
These pros should know better than to double down on a losing trade. But they're not showing restraint. They were bearish to start the year. And they've doubled down as stocks have rallied. Take a look...
These folks got incredibly bearish at the worst possible time in 2022, right around the bear market low. And they were still bearish as 2023 began.
The S&P 500 is having a fantastic year so far. It's up double digits. You'd think the reversal would have the pros cutting their losses. But they're doing the opposite...
They've doubled down on their bearish bets. Right now, the COT shows the most bearish reading since 2011. And before that, we haven't seen a reading this negative since 2007.
When I discussed this last month, I showed that similar readings have been great buying opportunities in the past. But today's message is a bit broader...
If you want to be a successful investor, you've got to check your ego at the door. You've got to admit when you got an idea wrong – or at least, when you got the timing wrong. And you've got to cut your losses and move on.
Understanding this is how most investment professionals become pros in the first place. But even the big players aren't immune to ego-driven mistakes, as we can see right now.
The easiest way to avoid the problem is to use stop losses on every investment you make. One simple option is a 25% trailing stop. If a stock falls 25% or more below its highest level since you've owned it, you sell.
It's not "sexy" or exciting. But it takes the emotion out of selling. And that's how you can keep your ego in check... and become a better investor.
Good investing,
Brett Eversole
Further Reading
"When you're selling, there's no room for emotions," Dr. David Eifrig writes. Most folks sell their winners too soon and ride their losers too long. Unfortunately, that can wreak havoc on your returns. A few key steps can help you keep a cool head – and make better investment decisions... Learn more here.
Your brain might be tricking you into a few key investment traps. It's all because of the common biases that pop up in everyday life... and in the way we think about money. Here's how to train yourself to avoid three of the worst pitfalls... Read more here.
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