When it comes to Stock Market investing, the basic play is to fund the investment regularly for a long time. But because of our era of fast information travel, many investors had become impatient and wrongfully applied this notion of being "fast" to investing.
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Because of this, many investors suffered heavy losses for picking the wrong stock to invest in. These losses can happen in two ways: One is picking the right stock but selling the position too soon because of impatience. Two is picking the wrong stock but holding it as it goes down because you've already been trapped in the Sunk Cost Fallacy.
What Is the Sunk Cost Trap?
By definition, A sunk cost refers to a cost that has already occurred and has no potential for recovery in the foreseeable future.
Is It Applicable to Investing?
It is indeed applicable, pretty sure you've already heard of someone taking the stance of a trader when everything is going up but when the stock turns south, he/she becomes an investor.
There is nothing wrong with changing stances depending on the market. However, the issue arises when you decided to become a trader or investor on the wrong stock. This is very hard to spot especially if you did not do your research and only bought because of the secondhand information.
Is It Wrong to Average Then?
As mentioned above, it depends on the stock. If you bought the stock intending to invest, then cost averaging is the correct technique to do. But if the stock you bought is for trading, then you need to manage your risk by getting out of the position once it hits your stop loss amount.
Takeaway
Risk Management is the thing that many traders/investors both newbie and seasoned failed to do. The justifications could be one of the following:
- It is just a small dip, it can recover
- I've invested too much, I'll still hold
- I've lost too much, I can't bring myself to let go
The first one holds because the market is unpredictable and you can't control its movement. The other two, however, are a controllable situation if you did not slip into the Sunk Cost Fallacy trap.
