How to Handle a Large Loss or Significant Drawdown
Experiencing a large loss or significant drawdown in your brokerage account can be devastating, especially if you are newer to the stock market and are dealing with this scenario for the first time.
For starters, remember that large drawdowns are part and parcel to managing money in the market. Nobody, and I mean nobody escapes dealing with this scenario at some point, for one reason or another.
This may happen for a variety of reasons, such as an overnight gap-down in the general market or in one of your concentrated positions. Going on a cold streak and getting chopped up slowly with small losses over time is another way we might find ourselves in this position.
If you are following a sound trading methodology and managing risk properly, this should not happen often. However, on the rare occasion when it does, it is wise to have a process in place for handling large losses.
The difference between an amateur and an experienced professional under these stressful conditions is how they react. Experienced professionals understand just how important the risk management process is to their overall success.
Remember, risk management processes involve your financial capital as well as your mental capital. The specifics for dealing with a significant loss or large drawdown in your portfolio must be accounted for in this process. Below is a glimpse into my process for managing risk during a significant drawdown.
William O’Neil would often say, “sell down to the sleeping point.” So one of the very first things I do under these circumstances is to reduce my overall size and exposure dramatically, even if it means going back to a 100% cash position.
This immediately takes a ton of pressure off your shoulders, which allows you to think clearly and begin to breathe again. I find this to be a very important first step, otherwise, it is next to impossible to make a good decision.
The next step is to assess the situation with a calm, clear mind. How serious was the damage to your financial capital? How seriously is it negatively impacting your mental capital? These answers will be different for each of us and therefore, so will the way we each cope and deal.
There is no one right way. On one end of the spectrum, you might consider taking some time off, completely away from the market, especially if we find that our mental capital needs some serious tending to. On the other end of the spectrum, we may be in a position to get right back on the horse again.
Regardless of when you decide to begin trading again, the idea is to begin with extremely small position sizes and only add exposure/risk once you are making worthwhile progress. As progress is made, your confidence returns and grows. This ultimately helps boost, protect, and preserve your mental capital.
Mentored by the founder of CANSLIM Ross Haber leverages years of experience identifying winning stocks and is well versed in recognizing the ones that outperform the general market. He now brings this experience to help you identify these stocks in each Top 10 Report.