When You Make a Bad Trade, Own It

A few weeks ago I wrote about the attractive qualities of investing in the Gap (GPS). I bought my calls, put my feet up, and waited for the profit to start pouring in.

Then lo and behold, the stock declined.

Investors are often counseled not to get emotional about stocks. But even after trading everything from futures on the floor to stock on the screen, when an investment declines so quickly, it's still hard to not be affected emotionally as well as financially.

One response is to pass the buck. Claiming that Gap was down only because earnings didn't meet analysts' estimates or because the economic data was weak is an easy way of avoiding a painful truth: I was wrong...at least for now.

So my response...and I believe the proper response, is to claim it. I've lost money in Gap. The problem wasn't the company, it's management, the weather, Bernanke or nefarious short-selling hedge funds. I'm the one who bought stock in the Gap. The problem was me. It's why most people are quick to brag about their winners but the losers are always someone else's fault.

Yet taking responsibly for a bad call is the only way to move past it. And a technical approach more easily facilitates that discipline. The fundamentalist must subjectively quantify and interpret the thousand different factors that influence business at the Gap and the price of its stock. But I can't spin a stock of mine declining into a positive thing. Indeed, for the technician, reality exist right there on the stock chart. The only question is how long it takes to objectively face it and let it go.

With proper technique, it's one's ego that's usually hurt more than the bottom line. My position size was reasonable enough to limit the impact on my portfolio, and because I own options, the exposure is technically still intact, at least for a little while longer. Any number of unforeseen events, from a buyout offer to a sudden bout of shareholder activism could cause the stock to pop over the next few months. But I have to admit that for now, that's looking much less likely.

And while I am a trader at heart, it's my firm belief that the big money is made on the big moves. For Gap to become a $50 stock, it needs to start by being able to hold $20, at least for a few days. Until it does, I'm not sinking a penny more into its shares.

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Jonathan Hoenig is managing member at Capitalistpig Hedge Fund LLC. At the time of writing, Hoenig's fund held positions in some of the securities mentioned.