Why you need to cut your losses: two investing mistakes to avoid
You may have heard the well-worn phrase, 'buy low, sell high'. This adage is obviously the aim of all investors looking to make capital gains. Achieving this, however, is easier said than done.
Here are some common mistakes to avoid. They're no guarantee of success, but can help tip the odds in your favour.
Don't overexpose a position
Traders can get sucked into putting all their eggs into one basket, especially if they think they're onto a real winner. After all, who doesn't want more of a good thing?
This behavioural tendency is what's known as the hot hand fallacy. Just because you've had wins in the past doesn't in and of itself boost your chances of having the same wins in the future.
For this reason, it's often better to diversify your positions across multiple assets. Better still, find assets that are uncorrelated or even negatively correlated to one another.
That said, it can also be a mistake to over diversify. Whilst having multiple positions spreads risk, more positions means more homework you need to do on each one. Fewer positions you have high confidence in is probably a better way to go than having many positions in assets you know little about.
Write off your losses
If a trade isn't working out, and you don't have any information to indicate its future performance will be otherwise, it may be time to exit the position and cut your losses.
Humans have a misguided tendency to continue an unsuccessful course of action in the hope it will come good. This is called the sunk cost fallacy. The more time and money you put into something, the harder it is to let go and seemingly waste the time and money you've invested in it.
However, experienced traders know that this is little more than wishful thinking. In this situation, it's better to sell up and move on. Yes, you'll have realised losses from the position, but you'll also eliminate the risk of further losses in the future.