The psychological stress created by the market during the downturn is very painful. Accepting losses in our portfolio is very difficult because it affects our ego. Losses in the stock market come in different forms, and each of these types of losses can be scary, but you can mitigate the period with the right mindset and a willingness to learn from the situation. In this article, we will discuss different types of loss incurred by the investor and give solutions to how to navigate them.
Different types of losses in market
Everyone invests with the hope of creating wealth for themselves. When the stock prices are rising, we feel good looking at our portfolio. As soon as, we enter a downturn in the market we feel very much scared. It is emotionally very difficult to see our hard-earned money losing its value in our portfolio. No one likes losing money. First, we must identify which type of loss we incurred in our portfolio.
There are mainly 3 types of loss:
This form of loss is most common and perhaps most painful. You buy a stock then watch the price go down. Now you decide to end your mental pain and sell it at some point. This kind of loss is referred to as a capital loss because the price at which you sold the stock is less than the cost of purchasing it. More than 90% of loss in everyone’s portfolio is a capital loss.
How to avoid Capital loss?
Know the difference between realized loss and unrealized loss of your money. If you invest Rs 10000 and the share price goes down by 20%, your unrealized loss is Rs 200. But this is no real loss. It becomes a real loss only when you sell it at Rs 800. If you don’t sell it at a 20% loss but decide to wait, then there may be a chance that the market will recover that 20% loss and your portfolio may turn green. Always remember, the unrealized loss is not the same as a realized loss.
This form of loss is less painful than capital loss and it is very hard to quantify it, but still, opportunity loss is very real in nature. You bought Rs 10000 worth of stocks and the stocks didn’t move anywhere for the next 3 years, then theoretically there is no real loss in your portfolio but you tied up your money in stocks that didn’t give any return. Instead, you could have invested in some other stocks which could have given you a higher return in that same period.
How to avoid opportunity loss?
One way to reduce opportunity cost is by buying the best investment possible, at the time you make your investment. There is no way that, you can completely avoid opportunity loss, but you can try to reduce it. Don’t settle for the second-best investment; always invest in the best investment keeping risk and reward associated with the investment in mind.
Missed Profit Loss
This type of loss happens when the stock price you invested, rise quickly and move 3 times to 5 times your purchase price in a very short period of time, and it suddenly comes back to your original purchase price. You have missed your opportunity to sell at top and book profit. This type of price movement happens in volatile and small-cap companies. But practically, selling at the exact top is not possible always.
How to avoid Missed profit Loss?
Have an exit strategy. Don’t try to sell at the exact top and don’t try to extract all the money because of your greed. Be less greedy and have a proper exit strategy. If you think that, the stock price has moved very fast in a short period of time and if you are happy then book profit gradually.
How to deal with losses in Portfolio?
Losing money in the market is very emotionally painful. When you are emotionally painful state of mind, most of the decisions you take will be not right. The best action is to cut your losses and move on. We will discuss 3 step processes to avoid any future loss.
Analyze your choices.
Review the decision you made with the new set of eyes. Review, what you did wrong in the first place. Also think, about what could you have done in the past which could have saved you from losses. Answering those questions will help you to avoid making the same mistakes twice. Don’t blame everything on market. The market has got no personal vengeance towards you. Don’t play the blame game.
Inculcate Strict Financial Discipline
Most people lose because of their poor financial habits. Tighten your financial discipline. This will ensure that your losses are less. All people in the market lose money, but those with strict financial discipline will lose less. That’s a big difference. Inculcating financial discipline is more of training your mind to control emotions like greed, fear, and herd mentality.
Understand the Psychology of loss
We feel happy when we make a profit of Rs 100. But we will fall 2 times more painful when we lose Rs 100. This is the psychology of loss. Making a loss hurts our minds more than the pleasure we drive from making a profit. So don’t let losses define you. Train your mind to see a loss in your portfolio as tuition fees you paid for the market. By paying tuition fees we learn some valuable lessons which no one can teach us.