Thursday, October 16, 2008

Cut Loss, Cut Lost or Cut Loose ?

Many have asked if Cut Loss is within my fundamentals and why I purposely avoid talking about them when I could have.  Well, because that is also another myth about it ... :)

Cut Loss basically refers to a situation where you get on a finance vehicle hoping for X return but turns out a Y loss instead.  Therefore you get out of that vehicle hoping to minimize the loss.

"I would sell when it gains or loss 20%."

The missing thing is "Time".  If you set an expectation without time, its like a dream never comes true.  You will end up letting your emotion makes decisions.

The 2nd major thing is ... what will you do with the money after you cut it loss ?  Says if you are lossing 10% now and may expect to loss another 10% further, but if you get out of that situation and get into another one that loss 20% eventually, its still a terribly bad deal !

If you know where you go Next,
then yes you may get out of the old lane.

Some may says if you just take it out and do nothing with it, 0% loss is better than lossing 10%.  Actually if you really understand the fundamentals of investment, doing nothing is the number 1 biggest mistake.  Doing nothing is actually much worse than lossing in an investment.  You may relate this to how to judge a good fund manager.

When you made a decision to invest into anything, you are actually testing your own belief, knowledge and ability to judge.  If result goes opposite of what you expected, that means you made mistake.  A mistake you made, is a  golden opportunity knocking on your door - either to save you huge amount of money in future, or increase the likelihood to reach your finance goal (conversion ratio, to be shared in later posting). 

Do nothing in investment basically also means learn nothing and therefore reach no where.

Not to forget, the fundamental way to buy into an investment vehicle is as if to start a business yourself. A good business owner does not just close down the business the first moment it lose money. When result goes opposite way, a good business owner will first re-analyse his initial assessment.  If he has done good fundamental assesment before, they should normally still stand firm.  Then he will assess current situation, "is it because the situation has changed and he needs a new assessment ?"  Eventually he will find out exactly why the result goes the other way.  If the cause is also fundamental and continue to exist in that investment vehicle, then yes, cut loss may be required.  If the cause of loss is something out of the business control like a global recession, the you should compare the loss with other similar type of businesses that you didn't invest in.  

A good business will loss less when everybody else are lossing.

So you cut loss when;
1. you realized you have made a mistake in your previous decision, you have learned from it and you will never repeat that mistake.
2. you found out some new information that you can no longer fine tune your investment method to cater for that.
3. you have found another better finance tool and you need more funds.

So if you really read above GOOD reasons to cut loss ... you may realize, cut loss has Nothing to do with LOSES at all !!  You may have to Cut Loss from time to time, no matter if it is earning or lossing.

Cut Lost is like Get Lost or Go Away, Leave me Alone !  Either you have earned enough and really get fed up with it, you just want it to get lost ...

Cut Loose is temporary let it go for a moment knowning that you will come back to it again.

So which route are you taking ?