Don't Fall in Love With Loser Trades

It may surprise you when I say that most traders are content with losing positions. Why? A losing position is typically the one we'll leave alone and fail to close out.

Admit it, you don't always use stop-losses, do you? Most people don't. The most common excuse is, "I don't like to put in stop-losses because the specialists and market makers will see where I've put them and will gun my stops." Do you really think the big players who can move around Microsoft (MSFT - commentary - Cramer's Take), Cisco (CSCO - commentary - Cramer's Take) and General Electric (GE - commentary - Cramer's Take) care about your meager 500 shares? I don't think they do.

So once you have a losing long position, closing it out presents a mental "Trifecta of Trouble":

You must admit you were wrong to buy it. Nobody likes to admit being wrong, so it's easier to believe you were just early.

If you do get past that hurdle, you'll also kick yourself for failing to short it. You'll look at the chart -- which is always easy to read in retrospect -- and see all kinds of clues that should've tipped you off on the stock's pending decline.

When you sell, the stock could promptly reverse and move higher. When that happens, you get whipsawed. It's not only embarrassing, but also costs you money! So you then have to decide whether to buy again and risk getting in at the top, only to have the stock drop again thanks to profit-taking by those who got it right.

Instead of dealing with the Trifecta of Trouble, you might choose to stick with your trade and play the only remaining strategy: hope. It rarely works, but it's very common.

Digging In Deeper

So you do what a lot of losing traders do: You buy more and average down. (Remember that old saying: "If you liked it at $50, you've gotta love it at $40.") That way you can become "less wrong," lowering your cost basis by throwing more cash into a losing position and bringing your average price closer to the current price. Of course, your position size is now much too large, but who cares? You have deftly avoided the Trifecta of Trouble!

There's just one problem. If the stock continues to move against you -- and Murphy's Law dictates that it always will when you average down -- you'll pay dearly for your misdeeds and suffer a huge loss. Those big losers are the most difficult to recover from. One big loss can wipe out an above-average year; it can put you right back on the night shift at the 7-Eleven.

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Dan Fitzpatrick is a freelance writer and trading consultant who trades for his own account. His columns focus on quantitative strategies for trading and investing. Fitzpatrick is a member of the Market Technicians Association and manages The Stock Market Mentor, a Web site focusing on the proper use of technical analysis for trading and investing. At time of publication, Fitzpatrick held no position in any stocks mentioned, though positions may change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While Fitzpatrick cannot provide investment advice or recommendations, he welcomes your feedback and invites you to send your comments to [e-mail].