Regret Has No Place In Your Portfolio

Welcome to Guest Post Week here at TRB.  My friend Kid Dynamite is one of the smartest guys in the whole financial blogosphere.  He’s also got a wicked sense of humor and is never afraid to call bullshit when someone is spouting nonsense in his arena.  Below, his guest post on regret (and how to avoid it). – JB

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Back when I was in high school, I wanted to get a Taz tattoo. I thought Taz was cool, for some inexplicable reason, and wanted him immortalized on my monstrous right tricep. In art class I made a 3 layer Taz silkscreen for printing t-shirts – hand cut it (yes, out of actual old school silk-screen stapled to a wood frame) with an Exact-o knife and everything. I wore those shirts for years, and I remember giving one of them to a girl who grew up on my street who was sick with Leukemia. She died shortly thereafter, sadly, but fortunately so did my Tax tattoo ambitions. Can you imagine?

A Mistake I Didn't Make

“Kid Dynamite,” you’re asking, “WTF does this have to do with anything?” Well, I have this Taz tattoo in my head recently as an example of something I would have regretted. I’m not sure what made me think of it -perhaps it was because I saw a lot of inked up people on my recent Hawaiian vacation.

These days, it seems it’s easy to get yourself into a regrettable, not-undo-able situation, as we’ve seen recently with unintended dissemination of dong pics (Favre, Weiner), ill-considered Tweets (take your pick – how about Gilbert Gottfried, who got fired for his), social networks that give too honest a look at our lives, or widespread online proliferation of every screwup we make.

Did you see this one about the Southwest pilot who ranted on an open air traffic control mic that eleven of his twelve recent crew-members were “gays and grannies and grandes” ??? You just can’t do that these days, because now someone puts the audio online to be forever immortalized. My favorite part of that one is that the air-traffic-control guy actually bursts in and tells the guy that he’s broadcasting out loud, and the pilot keeps going! (close runner up in this clip is the other pilot who comes on afterwards with a request for ATC and ends with “that was nooootttttttttt us.”

There’s an old joke, told best by Steve Martin’s character in My Blue Heaven:

Again – regret – things you can’t undo. “But seriously, KD, is there a point in our future?” I’m glad you asked. Let’s talk about your investment portfolio.

Regret doesn’t belong in your portfolio. You never want to find yourself saying “I wish I’d sold this stock when I could have, $10 higher, ” or “I can’t believe I doubled down on this pig as it went down – I wish I hadn’t done that.” You need to have the discipline to manage your risk in such a way that you avoid regret later. That doesn’t mean that you’ll capture every dollar of every move – it means you know that such expectations are unreasonable, and you manage your positions accordingly. Doing so will hopefully save you from the regret of saying “I wish I hadn’t been so greedy/stupid/fill-in-the-blank.”

Leigh Drogen enunciated some of these points in a zen-like comment reply to me many weeks ago:

“Knowing when to sell as I said is much harder than knowing when to buy, primarily because while you can learn entry pattern recognition through going back and looking at charts of stocks you did not buy, you can really only get that muscle memory experience in sell pattern recognition by actually taking positions. This is where even pattern recognition savants just need time in the market to sharpen their skills. The psychology of fear in having a position on, and seeing your gains taken away, is a very powerful learning tool. You can not get that by just studying charts as you can for entries.”

and then:

“Asking, “when has the trend reversed?” is the wrong question. The correct question is, when is the risk/reward of continuing to hold this position not in my favor, when has the meat of the move been made, when am I fighting for the last few points at the risk of seeing a good chunk of my gains taken away. Those are the right questions. It’s a different mind set, you shouldn’t be trying to time the end of the trend, because if it continues the stock will set back up with a good risk reward entry and you can always buy back in. Remember that line, you can always buy back in. In a 100$ move, if you catch 30$, miss 10$, then catch another 30$, and bail before the last 20$, you traded real well.”

Readers of my blog notice that I tend not to give a lot of trading advice. That’s because I think trading is largely psychological, and not something that is easy to discuss in typeface. I think Leigh’s wisdom above is a great “in a nutshell” simplification, as are the two articles I discussed in a post a few months ago “Fear and Greed – the Psychology Behind Momentum.” Learning how to trade is a long, evolving cycle, but a key thing I think everyone should keep in mind is the concept of avoiding regret. How do we do that? Options. Choices. Don’t back yourself into the proverbial corner. As Mikey McD said in Rounders:

“Always leave yourself outs.”

The most important advice I could give in this regard is: leave yourself room to grow a position – doing so means that if you were right the first time, and you miraculously managed to buy without any further downticks, that you wont make as much as you would have if you had a fully sized position on. More importantly, it leaves you room for flexibility if/when the stock does trade lower after you buy it – which you should EXPECT it to, most of the time, unless you are some sort of market ninja. The same thing goes for trade exits – if your position is so large that you can’t turn away from your screen, can’t step away to take a leak, or can’t sleep at night, then sell some. You don’t have to sell it all – and you can always buy it back. Manage your risk, and your sanity.

A colleague once told me, roughly 10 years ago (I remember the day like it was yesterday): “You can never buy the bottom.” Don’t expect to buy the bottom – expect the market to torture you with some pain, and prepare yourself to deal with it – that way you won’t find yourself unprepared and regret it.

To summarize: don’t send out pictures of your dong online, remember that everything you write on Twitter/Facebook/Myspace/YourBlog will be immortalized forever and used to judge you, don’t assume that your boss isn’t reading your Facebook page, and most importantly – don’t back your portfolio management process into a corner where you find yourself stuck with no options.

-KD

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