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What to Do When You're Wrong


The simple fact is that should you trade in the market, you will be wrong on numerous occasions.


If you trade in stocks inevitably there will be times when you are wrong. There will be times when you study a stock like General Electric (GE), Alcoa (AA) or Microsoft (MSFT) for weeks on end, finally deciding to commit capital and wind up being dead wrong. There will be other times when you feel a certain way about the general market, and despite this feeling that may be backed up by solid reasoning and fundamental analysis, you will be wrong.

Yes, there is always the debate about time frames in that a person can be wrong on Monday and right on Tuesday however I am a firm believer in viewing the here and now to determine whether my ideas are correct or not. Lately I have received quite a bit of correspondence surrounding the general macro economy and its scary future. Ironically, whenever I am asked my views on such things, I tend to always agree, however it does not stop me from attempting to make the proper decisions in the here and now.

Over the years I have learned that there is no problem at all with being wrong. It will happen from time to time, however it is also a gateway that if not cut off quickly can lead to further poor choices, a destroying of confidence, and ultimately the possibility of severe financial loss.

For example, one of the most blatant errors I have made in the last couple of months was attempting a trade in iRobot (IRBT). In early September the stock was setting up quite well for a potential break out and I took a position. The break out failed but the stock was still acting just fine. I held my shares to give the stock some time but was met with a significant drop a few days later when the company did not receive a contract, it was obvious many thought they would. At that very moment, it was clear I was wrong. It sounds a bit funny, but it is always true that admitting it is the first step. iRobot could very well have come back in just a few days and gone on to new heights, but the bottom line was, I was down around 15% in my trade, the stock was no longer even close to the technical set up I desired, and therefore I was very wrong.

Review some of Professor Tatro's trading rules in his Becoming a Better Trader series: Position Sizing, Let the Chart Be Your Guide, Legging In, Stops, Don't Fight the Tape, Play the Position, Not the P&L, and Don't Compare Yourself Yourself With Others.

Accepting the fact that you are wrong, as mentioned above, is the first step however correcting it quickly is step two. Many people at this juncture become paralyzed or zombie-like, not knowing what to do or what action to take. They realize they are wrong, however they start to rationalize the action and hold the stock starting to cling onto hope. Some will even invest more money thinking they are doing the proper thing by averaging in. Luckily, I have been in this situation many times, and knew the proper course of action was to correct myself very quickly, which I did by selling shares and moving on. The stock went on to creep steadily higher and I may have been better off waiting a few days, however the psychological effect the stock would have had on me would have kept me out of other areas that I played, making up the loss very quickly.

One should understand that simply because you are down slightly in a stock does not necessarily mean you are wrong however there is a fine line between being wrong and still having the possibility to be right. If you have identified a stock such as FTI Consulting (FCN) that is moving in a narrow range between $50 and $54, if you were to buy the stock at $53 and it temporarily heads to $51, I would not say you are wrong, however should it break below a clear stop level and start moving on to $48, you are wrong and now need to take the appropriate steps to correct yourself.

The simple fact is that should you trade in the market, you will be wrong on numerous occasions. The key however is to never let this damage you for more than is necessary. Once you recognize you are wrong, correct yourself quickly and move on. Accept the fact that you were wrong and let it go.

The market is awash in new opportunities each and every day, however if you are holding onto failed opportunities, you will never realize the new ones right around the corner. Accept the fact that you will be wrong, but make sure you know what to do about it when you are.
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