Learn How to Deal with Losses in the Stock Market

Frustrated Investor on Telephone
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Cultura

There's no way around it: at some point, you're going to lose money if you invest in stocks. Sometimes, the loss is immediate and clear: a stock price plummets. In other cases, your losses aren’t as apparent because they’re subtle. Losses come in different forms, three of which we cover here.

Each of these forms of losses is painful, but you can mitigate the sting with the right mindset and a willingness to learn from the situation.

Capital Losses

In its simplest and perhaps most painful form, you buy a stock then watch the price go down and stay down. At some point, you decide to end the pain and sell it. This type of loss is called a capital loss because it involves an actual dollar amount.

You can use a capital loss to offset profits, called “capital gains”, for tax purposes. A capital loss is a difference between what you paid for the asset and the amount you receive when selling that asset. Capital losses can be short-term or long-term. But beyond that, they're just a painful investing lesson.

Lost Opportunities

Another type of loss is less painful but still very real. You might have bought $10,000 of a hot growth stock and one year later, after some ups and downs, the stock is very close to what you paid for it.

You might be tempted to tell yourself, "Well, at least I didn’t lose anything." But that's not true. You tied up $10,000 of your money for a year and you received nothing in return. If you bought a bank CD instead, you would have earned a little bit of interest during that year.

Every stock purchase begins with a measurement against an investment such as a U.S. Treasury note. Ask yourself how much more could you earn purchasing a particular stock with some additional risk compared to what you could have earned on a note with no risk.

When a stock goes nowhere or doesn’t even match the lower-risk return of a bond, you're losing money. You lost the opportunity to invest your money in something that would have earned you a positive return over and above the risk-free return—and that is a true loss.

Missed Profit Losses

This type of loss results when you watch a stock make a significant run-up then fall back, something that can happen with more volatile stocks.

Not many people are successful at calling the top or bottom of a market or a stock. You might feel that the money you could have made is lost money—money you would have had if you had just sold at the top.

Many investors sit tight and hope the stock will recover and regain the high, but that might never happen. Even if it does, too many investors hold on hoping for even greater profits only to see the stock retreat again.

The best cure for this type of loss is to be happy with a reasonable profit. Don’t try to squeeze every penny out of a stock; you’ll risk the possibility of a retreat and a missed profit loss.

Paper Losses

You can tell yourself that your loss “is only a paper loss,” or, “If I don’t sell, I haven’t lost anything.” The reality is that if you make a mistake or something unforeseen happens, you have to decide what to do about it.

If you believe the company’s long-term prospects are still good, and you're a value investor, it might be a fine time to add to your holdings.

On the other hand, your paper loss becomes a lost opportunity if you believe this is where the stock is going to stay and you sit on that paper loss. If you do this, you lose the chance to invest your money in something that earns you a profit.

How to Deal With Your Losses

No one wants to suffer a loss of any kind. However, don’t let your ego get in the way of making the right decision when it happens. The best course of action is often to cut your losses and move on to the next deal. Take a deep breath and move forward:

  • Analyze your choices Review the decisions you made with new eyes after some time has passed. Could you have done anything differently? Would you have lost less or perhaps nothing at all if you had acted differently? Try to learn from the experience. 
  • Recoup what you lost Tighten your financial belt for a while if you must and if the loss is small enough that you can recoup it with a little discipline. Regain that money. Then try again, keeping in mind the things you learned for the next time the market gets shaky.
  • Don’t let losses define you Keep the loss in context and don't take it personally. Remind yourself that a lot of other people out there took a hit just like you did—perhaps even more of a hit than you did. The loss doesn't define you, but it can make you a better investor if you handle it correctly.

The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.

Article Sources

  1. Internal Revenue Service. "Capital Gains and Losses–10 Helpful Facts to Know." Accessed March 20, 2020.