Highlights in this issue:

*** Are you making my mistake…
*** Do you have a position in the red? Here are our 4 key rules to cutting your losses…
*** Successful investing is all about cold calculation… and more…

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From the pen of Karin Iten

Dear Investment Academy Reader,

Here at the Investment Academy, it’s my job to relentlessly search for and bring you the best potential investment ideas your way. But remember, you can easily undermine all of it by ignoring the basic tenets of investing. Last Friday, Tim Bennett showed you the one strategy you need to override your greed: Selling at the right time.

This week, Marc Lichtenfeld (one of our sister publication, Investment U’s key strategists) will show you another vital tactic. Today, he explains the best way to divorce yourself from atrade – without needing any counselling.

Let’s get into it…

Know when to hold 'em and when to fold 'em

One of the marks of a good poker player is someone who can throw away a good hand if he thinks he's been beaten. Successful investors do the same thing. A less experienced player might hang onto a premium hand, no matter what the board or his opponent's play may tell him. That’s why your first step to overcoming this is to remember this insightful trading expression: “Good investors know how to make money. Great investors know how to take a loss.”

But the real question is: Do you know when to hold 'em and when to fold 'em when it comes to investing?

The audacity of hope

When you buy a share, you do so having undertaken your research and due diligence. It feels good to be doing something proactive that you expect to have positive results.

Nevertheless, it's an act of faith. When the investment doesn't go your way, taking a loss is one of the hardest things to do following your initial optimism.

I've heard people say, “It's not a loss until you sell”. That may technically be true, but I've also seen 10% losses on paper become 100% real life losses with that mentality. And the truth is, when you sell for a loss, not only are you admitting you were wrong, but you're also taking a hit to your portfolio.

So with that said, I'm going to do something that is unheard of in this business...

Time to “brag” about a loser

Typically, analysts love to tell folks about all the wonderful gains they've racked up over the years. Of course, we're truly happy with the winners and I'm personally very proud of my track record.

But I'm going to break with tradition and “brag” about a loser.

In August 2008 I recommended shares of a small medical device company called Somanetics (Nasdaq:SMTS). I did so expecting earnings would increase as more hospitals used the company's technology to monitor oxygen levels in premature-born babies.

But despite my best efforts, the trade didn't work out. Here's why...

The right way to take a loss

Think back a few months, mid- to late-2008 wasn’t a great time for the stock market. As a result, SMTS shares fell. In October, SMTS hit my customary 25% stop loss at $16.46. Naturally, I decided to take the hit and move on.

But what if I'd been stubborn and let my pride get in the way of this losing share?

Aside from being irresponsible, it would have been reckless. The share went on to hit a low of $10.16 in March this year.

Yes, they've rallied with the broader stock market since then and have scrambled back to the mid $16s (where I sold it). But if I'd insisted my analysis was right and that the shares would eventually go up, I’d have had to live through the emotional turmoil of seeing the share drop by more than 50%. On top of that, my money would’ve been dead for a year.

But by cutting my losses, I was able to re-deploy cash into other winning investments. So yes, I took a loss, but it's often better to just move on, rather than wait for the share to meander back to breakeven, just because you refuse to admit you were wrong.

Got an exit strategy? Here's your checklist...

Keep these key rules in mind when you're faced with a position that’s in the red...

1) Use a stop loss:
I can’t stress this enough. Using stop losses is something all my colleagues here at the Investment Academy advise. Simply put, it takes the emotions out of selling your position and helps you resist the temptation to hang on in stubborn hope, rather than solid expectation. Selling for a loss is difficult, but if you’re disciplined you should exit the position automatically. And if the share creeps to your stop loss point, don't change your exit strategy. That's a recipe for disaster. It's there for a reason, so use it.

2)  Don't let trades become investments:
If you have a reason for getting into a trade, such as a chart pattern or near-term catalyst, and events don't unfold the way you expected them to get out of the position. Don't hang on to the share if your original analysis has changed. Move on.

3) Check your emotions at the door:
Sure, there are companies and people behind the shares you own, but you shouldn't consider shares any more than pieces of paper. Don't assign an emotional value to a company just because it does something cool or develops cancer drugs. You should buy and sell shares with cold calculation, not because it gives you a warm, fuzzy feeling.

4) Use a stop loss:
See #1!

Believe me, I know what I'm talking about. Early in my investing life, I bought shares in a dotcom company whose price eventually went to zero. I was raw and let my emotions drive my decision making and never sold a single share. It makes me sick to my stomach when I recall how much I lost and how I could have avoided most of the pain if I'd employed a 25% stop loss and exited the position. Even if I'd simply put the remaining money in the bank, I'd have paid for at least a year's worth of my son's tuition.

Then again, maybe my eight year old son will be able to pay his fees with his poker winnings. He's becoming quite the player. Last time, for example, he folded pocket aces when he thought he was beaten. He was. But by saving his chips for a better hand, he later crushed his mom and I!

Here’s hoping your longs go up and your shorts go down,

Marc Lichtenfeld and Karin Iten
For the Investment Academy