When a thesis breaks down, my gut knows it immediately. After years of investing, i know when it is not working
The problem at this point is loss aversion and the discomfort of being wrong
My immediate reaction is to look for a silver lining and give the thesis ‘time’ to play out, in the name of buy & hold or some other rationalization. Once I get into this mode, it becomes a hope trade with years of opportunity loss.
In the last few years as I analyzed my stats, it hit me that this was costing me 2-3% of annualized performance. A great book which helped me move forward was ‘thinking in bets’ and the quote in the book – ‘When you cut losses, it always ‘feels’ early. I have taken this maxim to heart
This is what I do now –
- Allow myself to be angry at the company, management, myself, the world, my dog ..whatever comes to mind
- Allow myself to feel stupid
- 1 and 2 happens quickly now. I exit the position after the initial emotional reaction – call it ripping the bandage
- Immediate relief after the exit
- Allow the mind to clear up (which feels great)
- Get on with finding a new idea – better yet, I have a pipeline of ideas and the next one is ready for replacement
- A month or two later, when the emotions are gone, I sit down and analyze what went wrong and try to draw lessons from it
I used to go through self torture each quarter after a few of my thesis broke down. Now I expect atleast 30-40% of thesis to break each year. I just repeat the 8 steps above and move on
