Losing money is painful, but when the stock market crash, it is often unavoidable.
As investors, you need to learn how to deal with losses in the stock market and move on.
Unexpected events such as the trade war between China and United States in 2019, and Coronavirus (Covid-19) in 2020-2021 can cause the stock market to plunge more than 10% in just a day.
Market loss can come in 2 ways:
- Immediate: The loss is clear, where the stock price plummets down like no tomorrow.
- Slow: The loss can be subtle, where the stock slowly but gradually drops in price over a period of time.
While not everyone can handle the shock of seeing their portfolio shrink 10% to 50% in value, understanding the types of losses in the stock market helps you to deal with it when it becomes a reality.
Read Also: 7 Deadly Sins of Beginner Investors
How to Deal With Losses in The Stock Market
Dealing with losses is not easy, and there’s no getting around the fact that losses will occur in the stock market from time to time. In fact, there are 4 types of losses in the stock market you may face as an investor.
- Paper loss
- Opportunity loss
- Capital loss
- Profit loss
As an investor, anything that can happen will happen, this includes losing money in the stock market. Thus, it is important for you to learn how to deal with these painful losses when the undesirable happens.
1. Paper Loss
Paper loss in investing is a situation that arises when the market value of a security falls below the price at which it was originally purchased. Paper loss is an unrealized loss in an investment. A paper loss is only realized, or actual money loss when the investment position is closed or sold.
Thus, many investors have this mentality,
“If I don’t sell, I don’t loss anything,” or “It is just a paper loss, it will be alright.”
Does this sound familiar?
Most investors believe that if they don’t sell their stocks, it is just a paper loss. If they don’t sell, the loss won’t be ‘realized’, thus ‘no loss’.
But in reality, the price of your stock has dropped.
A drop in the price of a stock is not always bad.
In fact, you can perform 3 types of actions:
- Sell and cut losses
- Buy more at a low price
- Do nothing, wait and see
What’s important when you are faced with a paper loss, is to understand the reason for the drop in the price of the stock.
Do not ignore the paper loss, but understand the situation and perform the best course of action for your investment.
How to deal with paper loss when Investing?
Many successful investors when faced with a paper loss, will try to identify the reason for the drop in prices.
Their course of action will depend on the reason for the drop in the price of the stock.
Smart investors buy when they believe the company’s long-term prospects are good with good financials.
When this is the case, the drop in price might be an opportunity to add more to your portfolio at a cheap price.
Smart investors sell when they believed the drop in price is due to the moat of the company being destroyed and the company’s financials are in bad shape with lots of debt.
When this is the case, it might be wise to cut your losses.
2. Opportunity Loss
Opportunity loss in investing is the lost chance or a potential profit that could have been gained if an opportunity had been seized, but was not realized because the course of action taken did not permit the investor to earn the profit.
Opportunity loss may not sound as painful, but in reality, a loss of opportunity can have a huge impact on your wealth-building strategy.
You might have brought $20,000 in a hot stock recommended by a cute barista down the street. After 5 years of buying that stock, the price remains around the price you have paid. Furthermore, no dividend is paid for the 5 years you hold the stock.
You might even tell yourself, “at least, I don’t lose anything holding to this stock.”
It might be true that on paper, you don’t receive any form of loss.
But in reality, you have tied up $20,000 of your money for 5 years and received nothing.
If you have placed your money at some risk-free investment such as the U.S. treasury bonds, you may have earned at least 1% to 2% per annual.
Although this level of return doesn’t even beat the rate of inflation of an average of 3% to 4%, it is still better than nothing.
What you lose, is the opportunity loss to better allocate your money to somewhere which gives a better return.
How to prevent opportunity loss in investing?
When buying any stocks, it is always a good practice to ensure you will be getting a higher rate of return than a risk-free investment such as the U.S. Treasury Bond.
At least 3% above the risk-free alternative will be a good guide when buying any form of stocks.
With the increase in the risk of each stock, you may want to have a higher rate of return.
Although, risk and the rate of return do not correlate exactly (It is totally possible to find a low-risk investment with a high rate of return), when you buy a stock that doesn’t even match the risk-free return of the U.S. Treasury Bond, you are basically losing money and exposing yourself to unnecessary risk.
Read Also: Warning Signs of Stock Market Crash
3. Capital Loss
A capital loss is a loss when the price of the stock has decreased in price from the initial price you have brought. This loss is not realized until the stock is sold. When the stock is sold, it is called “Realized Capital Loss”.
Perhaps the most painful and simple form of loss that many investor have experienced.
But sometimes, selling a losing position is the right thing to do. It is better to end the misery early than to suffer the pain of the loss indefinitely.
What to do when your investment is facing capital loss?
Capital loss can be painful, but sometimes selling the stock at the loss allows you to prevent yourself from suffering from an opportunity loss.
Although, you may have lost some money, due to a bad investment decision.
You will have extra cash on hand to invest in a good investment if the opportunity arises.
4. Profit Loss
Profit loss is the loss of potential profit due to a significant stock run-up after you have sold the stock at a lower price than the current.
Yes, you may feel you have “lost money” because you didn’t sell at the top of the market.
You may even blame yourself for selling your stock now, taking just a 50% profit, when you can sell your stock a few days later, where you can get an 80% profit.
But the fact is, no one in the world, not even Warren Buffett can time the market correctly.
It is impossible to ensure that you can successfully sell your stocks at the top of the market, and buy at the bottom of the market.
Many investors hope that the stock will recover to regain the last high, but it almost always doesn’t happen. Even when the stock, does regain its last high, or have exceeded expectation, some investor holds on to their stock till the stock plummets in price, leading to a painful loss in investment.
How to deal with profit loss in investing?
Knowing and understanding that no one can time the market to maximize your profit is probably the key.
No one will know when to sell a stock where the stock price is at the highest, and buy when the stock price is at its lowest. Not even Warren Buffett.
Be happy when you are able to invest and gain a nice profit from the investment, don’t try to squeeze every dollar out of the stock.
Stock price almost always reflects the value of the stock, when the stock is over-valued and you are getting a good profit from the investment. It might be a good time for you to sell your stock and realize your profit.
“In the short run, the market is a voting machine, but in the long run it is a weighing machine.”Wisdom of Warren Buffett
Read Also: Ways to profit from a Market Crash
How Do You Handle Loss in Stock Market
Loss in the stock market can be a painful experience, but every great investor learns from their experience and grow. Keep the loss in context and don’t take it personally. Know that every great investor learns from their mistakes and gets better.
Many successful investors experienced these common types of losses in the stock market.
- Paper Loss
- Opportunity Loss
- Capital Loss
- Profit Loss
Dealing with losses can be tough.
But do all babies learn to walk in just one try? Or do babies learn to walk after many falls over a period of time.
After each fall, the baby learns to balance their body with their hands and legs. Eventually, the babies start to walk and even run.
Investing is just the same.
Recent market crashes
- Dot Com Bubble in the year 2000
- The housing bubble in the year 2008
- World recession in the year 2020 caused by Coronavirus (Covid-19)
These market crashes have struck fear in many investors, and many might not pick up investing ever again.
Do not to live in the past, look forward and see what can you learn from the losses.
I too have learned from my mistakes when I just started investing years ago.
Journeying the world of investing as KopiBuddy, I wish to share what I learn with my readers.
If fact, if you want to learn how to prepare for a market crash and profit from it, you can read this article on “How to Profit from Market Crash“.
Investing is a lifelong journey of constant learning.
“Education is a progressive discovery of our own ignorance.”Will Durant
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