Small Cap Investors: Do you have a strategy for managing loss?

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Market is going up everyday & touching new highs. I am sure you will be happy to see your portfolio grow stronger than ever. However, it will be different challenge when market slides down. As humans, we have affinity towards profit and aversion to loss. However, the fact is that loss occupies more space in our mind than profit. Markets are bound to go up & down and as ace investor, we should be ready to deal with both situations. So, do you have a loss containing strategy? If not, we are sharing some of our thoughts & explaining its impact, if not managed properly.

Losses are inevitable, we like it or not. Infact, there is a saying in wall street that if you have not made losses then you are most likely to fail. The logic is that losses make you learn from your mistakes. Your writer has also faced terrible losses in Intellect Design Arena and it has been a lesson for future. This is even more relevant for a small cap investor since risks & volatility is even higher in small cap universe.

Everyone will have a stock which remains in loss all the time. This is very frustrating but let me tell you that the mathematics of loss is a little deeper than what meets the eyes and this is a reason why impacts are greater and some stocks remain in loss even in bull market. To explain this, we have a graph which explains how much percentage rise it will take for your loss making stock to break-even.

Loss in % Rise in % to Breakeven % Jump in Breakeven %
-10% 11% 0%
-20% 25% 127%
-30% 43% 72%
-40% 67% 56%
-50% 100% 49%
-60% 150% 50%
-70% 233% 55%
-80% 400% 72%
-90% 900% 125%
-95% 1900% 111%
-100% Forever

If you see any loss more than -30% or -40%, it is difficult to repair since it will need more than 67% rise to barely break-even. This gets even steeper beyond -40%.

So what does this tells us? It teaches us a number of good practices to follow:

1. Never love a stock beyond a certain point. No matter how good a stock is, the amount of recovery it needs is very steep to come back to your original purchase price. This is easier said than done since once again our bias towards it comes into the picture.

2. Give second chance at a later stage.  If you believe that the stock is good, your investment theory is still valid and fall in stock price is merely market’s over-reaction, then you can always make a come back when prices have stabilized at a lower levels. But having strict stop loss percentage helps in preventing huge loss of capital & sleep. No stock is worth your sleep! This stop loss can vary from person to person. Personally, I will settle at max of -30% to any stock.

3. Skip average down strategy. Since in this article, we are dealing with stocks having bigger losses (> -30%), we have skipped a popular strategy which is to average down a stock. Basically, averaging down a stock is to buy more shares at a lower price in order to reduce your average price per share. We do not recommend averaging down to common investor as it’s wild goose chase which will make you commit even more money into a loss making stock. Unless, you are a market expert like Prashant Jain or Warren Buffet, it’s better to skip it. Instead, we advise you to average up a stock where money is invested on well performing stock. Click here to read about how to average up a stock.

4. Always outsource some portion to experts. When it comes to managing your own money, it is not easy to take unbiased decisions all the time. That is a reason, we believe everyone should outsource some portion of his or her investment to someone else who has time & expertise to do it on your behalf. It can be used as a second opinion as well. Now a days, professional money managers use outside research as second opinion to validate their conviction. Some people may label it as lack of confidence but in reality, this is a smarter strategy since it de-risks investment decisions from your own bias. We have our portfolio service called MultiCAP Multibagger which empowers our members to take investment decisions backed by our research & expertise. If you are also interested, click here.

PS: For our new joiners, here is your free stock report.

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