Don’t Get Emotional, It Can Cloud Judgment

If you have a large, unhedged position, yesterday was probably the time to put in some sort of risk control.   Further, if your position reflects one of the following characteristics, you may have developed “blind spots” and/or an emotional attachment:

• Owned a position for several decades
• Experienced a nice return along the way
• Have a good sense of security
• Been generously compensated in company stock
• Someone who recently inherited a large position

This attachment may cause you to lose sight of some risk factors including under-performance, a changing macro landscape, mismanagement, or fraud, among other issues that can destroy capital.  Recent instances of these risks are not hard to find: GE, AIG, and Enron, are fine examples of what happens when good stocks go bad.  Further, it’s conceivable that if you had blind faith in any one of those stocks, you could have ridden them to the bottom. 

Will most stocks end up like that? There is a high probability that they won't; however, not having adequate risk controls on a large position can destroy capital if you convince yourself the stock will turn around on the way down.

We use strategies as simple as selling at various targets or shaping the portfolio around that position to more complicated strategies like using derivatives.  Everyone is different, so if you use a risk management strategy make sure you pick the one that is right for you.