Holding a losing trade can hurt you in a lot of different ways. This page looks at the damage and offers a possible exit strategy.
Occasionally, I get an email from a day trader with a similar message. "I'm holding a losing trade. How do I get out of it?" By the time I get this email, the trade has gone against this person by a large amount. Often, they are several thousand dollars in the hole. Panic sets in as their equity is tied up in a long trade that only wants to go down further.
This damage is more than just our bank account. When we are holding a losing trade, our stress level mounts (not too healthy); we go through stages of anger, denial, etc. (similar to stages of grief); and we're so far underwater on the trade that we can't imagine selling it here and taking the financial loss.
What has happened here is that we have turned our focus onto ourselves and our emotions. We are no longer focused on the chart in front of us. Now it's a matter of pride and we feel as though we've betrayed ourselves. Our goal, after all, was to make money in this trading game. And now, here we are holding a big loss. We tell ourselves that it's not technically a loss yet because we haven't exited the trade at a loss. So we hold a little longer, thinking it will all work out in the end. Unfortunately, it doesn't always work out.
So, our equity is kidnapped by this losing trade. And though we may hope for a turn around in price, if often doesn't happen. The reality is that the stock could take months before it turns around...if it ever does. In the meantime, you continue to kick yourself for letting it go this low, for not setting a stop, etc. These are the sorts of trades that can make a day trader give up a possibly profitable future, not to mention the fun of explaining the lose (or hiding it?) from your significant others.
Before I begin talking about a solution to this problem, I first want you to accept responsibility for the trade. You need to figure out why you allowed this situation to occur in the first place. This is a teaching moment, from the market to you. So listen up. Did this occur because you placed too much equity into one trade? Did it occur because you never place stops on any of your trades? What does this fact tell you about your risk assessment? Do you have a maximum acceptable loss philosophy? For example, what is the most capital you're willing to lose in one day or on one trade? These are all important questions you should be asking yourself during this situation.
But, hey, you're in it now so how do you get out of it?
The following strategy assumes that you are a trader who has a proven strategy in place for making money in the market. In short, I assume that you have more winning trades than losing trades and your winning trades earn more per trade than your losing trades lose per trade.
The following strategy is sort of life a life jacket being thrown to a person who has fallen overboard. It's designed to help you take action and to get you back on dry land.
1. Think of the bad trade you're holding as a kind of debt. You are holding negative equity, so it really is a sort of debt.
2. You have to take some action. The longer you sit on a losing trade and do nothing, the worse the damage. In my experience, a trade that goes against you will continue to go against you. So, doing nothing just makes the situation worse.
3. Start by selling 10% to 20% of your shares. That's right. Go ahead and take some loss. Since you are no longer in control of this situation, you need to regain control. You do that by taking action. If you see a cancer growing, then you don't just sit there and watch it. You've got to swallow your pride and take some bold action here. But, taking the full loss at once is usually too much for most people.
4. Take this newly found equity and begin to trade with it. You are taking the 10-20% stake, regaining control over that money, and putting it to good use (hopefully).
5. Be careful not to get into another losing holding pattern with this new found equity. If you're day trading, and the stock moves against you this time, then be willing to accept a small loss. You cannot afford to tie up this equity in a similar situation as before.
6. So far, you've taken action, started making money again, and you're already feeling better about yourself. That's important. Trading is a mind game of sorts. Sitting on a losing trade for a long period of time can destroy your mental game.
7. Now, take the profits from this winning trade and buy down some of your debt. For example, if you made $200 on your last trade, then take that profit and let it cancel out some of your bad trade debt. In short, take $200 in losses from your losing trade. Yes, this is a zero net gain. But, you're digging your way out of a bad trade. You're getting out of debt. And, at the same time, you've freed up more equity now for the next one or two day trades.
8. You do this process over and over until you get out of debt to this losing trade. You make some money, use it to get out of the bad trade, increase your trading equity, and make more money. You repeat this process over and over until you're back on solid ground.
Using this strategy is not a quick fix. It will require discipline and diligence on your part. It will cause you to be extremely focused. But it gets you out of the hole over time. And it's much better than just sitting there and doing nothing. It's also much better than averaging down because you assume the stock "just has to come back up eventually".
I wish you successful trading. If you'd like to read more information about exit strategies, then click this link to read about losing trades and other exit strategies.