Bitcoin hit another all-time high this week, and everyday investors quickly made (and lost) fortunes on stocks like GameStop and the meme-turned-cryptocurrency Dogecoin. These purchases are risky, especially if you don’t know when to fold and when to step away from the table.
Fear of Running Out (FOMO) may make you want to participate in these investments, but it also prevents traders from exiting when they should. Suppose you hit the jackpot on $ 100 of Bitcoin you bought in 2011 and you are sitting on over a million dollars. It’s probably more money than you’ve ever had, but if you could have… $ 2 million. Sometimes taking a huge bet works; Mark Zuckerberg could have sold Facebook to Yahoo for $ 1 billion, but he didn’t and he’s now one of the the richest people in the world. But we’re not all Mark Zuckerbergs and as quickly as those returns can double, they can also disappear. GameStop, which was trading at $ 483 per share at its highest in late January, is now trading around $ 50.
So how do you balance the fear of selling now and potentially missing out on bigger returns, while making wise investment decisions?
If you are a 100% rational human being, the answer may seem simple: you currently have more than you had when you started out, so end the risk here and go with your returns. But none of us are 100% rational, and the potential for your returns to skyrocket in a matter of weeks or months could, of course, make it difficult to sell.
When an investor sees a gain in his trading account that he has not yet sold, he tends to take more risk, says Dan Egan, general manager of behavioral finance and investments at robo-advisor Betterment. (If you have actually sold these assets and seen the tax bomb, that may be another story.)
And when investors start to see a loss, they usually dig to defend their positions, says Robert Frank, professor of economics at Cornell University.
“If someone goes to the racetrack and they are late for the last race, they are much more likely to bet on a long shot in the last race, although it is not a smarter bet. Frank says. “Betting on a long shot – if he wins – could help him avoid a loss. “
When someone has proof that they can make money this way once, they’ll wonder if they can do it again… and again… and again.
But novice investors should ask themselves: am I really good at trading or am I just lucky? We hope for the first, but it is better to plan for the second.
What you should do
For every investor we see in the news making a lot of money, there are tons of them on the other side who have lost a lot of money – and next time it could be you.
“When you get such a deal, you want to eliminate the risk,” says Anjali Jariwala, certified financial planner and founder of Fit Advisors. “The best way to do that is to withdraw that money in increments. “
If you put money into the market and that position has accelerated, at least withdraw what you put in so you can get your investment back, she says. If it keeps going up, consider selling half so you’ve made some money, but you can still wait and see if there is more to be gained. Of course, if you’re more risk averse, selling once you’ve seen that jump in price might be the best decision for you (stop while you’re ahead, as they say).
If you’re new to self-directed trading, divide your money into a “get rich” pot and a “stay rich” pot, Egan says. The “get rich” prize pool is a small part of your wealth where you can experiment with trading, and the rest should be in more risk-managed vehicles, like target date funds. As your “get rich” pot increases, rebalance it and bring it back to where it started.
If you are really good at trading, you can make money this way. But rebalancing protects you in case you got lucky once and you’re not really good at it, Egan says.
Keep in mind that experts recommend having no more than 2% in riskier investments like Bitcoin – 5% at most.
It is also a good idea to make a plan before you start trading. If you buy a stock for $ 100, for example, tell yourself that if it ever hits $ 200, you’re going to take out or at least withdraw half of your earnings, Egan says. And if it’s a hobby, treat it like a hobby. Set a budget for yourself like you would for skiing or the climbing gym.
Finally, if you are one of the lucky ones who are making a lot of money fast, don’t change your lifestyle. If you make $ 100,000, spend only $ 10,000 more that year, Egan says.
“Having to downshift from a Bentley to an Audi is really bad,” he adds. “It’s much worse than good on the way up.”
I can’t understand, but the point is, the losses are considerably worse than the gains.