Losses are a part of the game. Well, I use the term 'game' loosely but it can be that way just like life. But, as with life, we like to be in control to what extent can be reasonably expected.

Losses of course mean different things to different people and so we will try to put this into some context.

The losses I may tolerate today are at a level I would not have considered in my wildest nightmares when I first started on the path of investing. So it is important to spend time contemplating what this seemingly simple word means, in general and specifically to you. As you contemplate such matter - maybe even do some jottings and revisit them throughout your investing career - see how your view changes over time.

Your financial circumstances will most likely change, but what is likely to change even more so is your skill level and therefore your understanding and tolerance of losses.

I don't want to talk about stop or profit losses here as I have written much over the years on this and you can search the TTN archives for more on this.

I just want to make a few key points that fit into my theme for this series of articles on the "Seven Deadly Sins of Investing."

My first major point is not to take losses for granted. Your starting point must be to be intolerant of losses but then accept that they will happen. So given that we now want to control them, how we do that will be part of our stop loss strategy and in turn part of our WRITTEN PLAN.

Accept small losses as part of the game but never accept larger losses or wipeouts as part of the game. You may retort, who would do that? Well, just think back over the past couple of years and the numerous high profile business people and investors who did just that. And this will happen through time immemorial.

And yes many readers of this editorial will do just that - and maybe over and over again - despite agreeing with all that is written here.

Another much misunderstood aspect of losses is that loss tolerance will vary according to the instrument you are investing or trading and the investment time horizon. Of course, the major variant will be between investors as we all have different risk profiles. So I cannot specify what should be your risk plan. All I can do is maybe suggest some pointers.

For example, if you trade futures or foreign exchange you may have to accept a lose:win ratio of say 35:65. That is, your stop losses may get you out of 65% of your trades at a defined loss but you let your profits run on the other 35%, and this is how you win overall.

With straight shares - as opposed to CFDs or Margin - you may expect a lose:win ratio of say 40:60. And I hear cries of horror from some who expect a 100% hit rate for shares 'over time.' That is not the real world. Losses happen and you need to do something about them.

I know some investors follow broker advice and take a 'five-year view'. I just think that is a whole lot of bollocks. Because many investors blindly follow this erroneous guideline they consequently never sell - or sell at the last gasp as the stock is about to rise again. Selling or realizing losses must be part of your plan and not happen in fits of emotion or randomly for any other reason.

The above is not intended to be a complete treatise on losses, rather only a basis for thought and further active debate and definition - with yourself. To do it any other way will result in another deadly sin being committed - that is, expecting manna from heaven.

Enjoy the ride

Tom Scollon
Chief Analyst
Trading Tutors Team