Hall of Fame football coach Vince Lombardi once said, "Show me a good loser, and I'll show you a loser." It is an understandable sentiment in sports where the effort to never fail, never lose, and never stop is the key to success. There is no upside to giving up and admitting that you are going to lose in a sport like football.
In other endeavors, it is extremely important to admit when you are in a poor position and are unlikely to prevail. For example, professional poker players fold a substantial number of their hands. It is smart strategy to take a small loss immediately rather than to keep pressing when the cards are not in your favor. You may end up with some good luck if you stay in, but it isn't the smart bet. It is better to protect valuable capital and wait for a better opportunity to come along.
Poker players that fold don't feel embarrassed or ashamed when they fold. It is an essential strategy if they want to win. It is just part of the process of professional gambling, and it helps to improve the overall odds of winning some money.
Taking losses when you trade stocks should be no different than folding a hand in poker. It is essential to long-term success, but, unlike in poker, many traders are reluctant to fold and to admit that they are in a bad trade that is unlikely to work. They tie up not only their capital but their emotional energy in trying to overcome a situation with a low chance of success.
Bad trades are too often viewed as a personal failure and a badge of shame. There can be great pressure to pretend that our stock selection is perfect and our decision-making always results in profits.
While it is important to strive to do our best, it is extremely important to recognize that in the stock market that it is impossible to be perfect. The goal of trading isn't perfection. The goal is to make as much money as you can when you are right and to keep losses small when you are wrong. You can be wrong far more than half the time if you make the most of your winning trades.
The primary benefit of losing trades is that they allow you to take more risk. When you try too hard to never lose, the likelihood is that you will never take on very much risk. If you only took trades that you were positive would succeed, you would never take on a trade.
A common problem for many traders is "analysis paralysis." Rather than putting their money on the line and seeing if a trade works, they keep on looking for an edge that will guarantee that they can't lose. They want the perfect setup, but by the time it becomes clear they are right, the big move has already occurred.
Jesse Livermore, who is considered by many to be one of the greatest traders of all time, would use a strategy he called 'probing trades' to determine if he was on the right track. He would quickly put some money on the line and then watch the trade as it develops. If he felt good about it, he would leverage up his investment. If he didn't like the way it was acting, he would take his loss and move on. There was no shame in buying wrong. The losses he suffered while probing for big winners were just part of the process, much like folding a hand in poker.
Not only does this fear of being wrong cause traders to avoid taking trades that may turn out well, but it often will keep them in a trade that isn't working. The longer a trader holds a stock that isn't working, the more likely it is that they become invested in it emotionally as well as financially. It becomes increasingly difficult to cut a laggard when you have watched it in your portfolio for months or years. We are all prone to what is known in behavioral economics as 'confirmation bias,' which means we only look for evidence that confirms our positive viewpoint.
Many of my best trading results come from trades that look poor at first, but if I was overly precise with my entry points and waited for perfect conditions, I would never even be in the stock. Sometimes you just have to put your money on the line and see what happens.
The stock market isn't like baseball. You don't need to have a high batting average to produce huge returns. As long as you have capital, you have an unlimited number of swings.
If you aren't producing a steady number of losing trades, then you aren't trying very hard. As hockey all-star Wayne Gretzky once said, "You miss 100% of the shots you don't take."