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Release the hounds

TORONTO (GlobeinvestorGOLD) - It's the New Year, time for me to risk blindness by tackling the Globe's annual mega-crossword puzzle (here's a hint, guys: try making the squares a little bigger, my trifocals can barely handle it as it is). It's also time to make the traditional New Year's resolutions.

I've never been big on making resolutions - most of them are more observed in the breach than in practice, especially the ones about working out or losing weight, which are usually abandoned by Groundhog Day - so 2006 won't be the year that I finally get in shape ("the Year of the Body," as my old roomie used to call it, before lapsing back into his usual torpor on the couch with the TV remote), drop a few pounds, learn Esperanto, take up Yoga, or write the Great Canadian Novel (well, maybe in 2007). But I am making one investment resolution this year: shoot the dogs.

That's my resolution. One of my basic rules of investing is to sell any stock that is down 15 per cent from where I bought it. Your first loss is your best loss, as the saying goes. All the professional traders I've known over the years, including Jane the Impaler, the intrepid Skunkhead and the legendary Prince of Darkness, have always stressed this rule. Go read those books that are advertised in the back of Futures magazine, the ones on "Secrets of the Market Masters," and they all say essentially the same thing: You put on a trade and it goes against you - get out. Always know your pain threshold before buying a stock; how much it can get underwater before you bail out. I figure 15 per cent is enough room to allow for a little price volatility while still offering a margin of safety, though you may want to set a higher or lower limit, depending on your tolerance for pain.

Now, last year wasn't too bad for me, investment-wise. My RRSP is up over 20 per cent from December 2004, thanks mostly to the energy sector, which I've been long since 1999. But as I look at my portfolio, I do hold a few dogs, and they all have one thing in common.

They are all stocks that I bought that I did not sell after they had dropped by 15 per cent. Instead, ignoring my 15 per cent rule, I bought more, averaging down (and down and down and down in one case). Breaking the 15 per cent rule has left me holding one stock that is now down over 60 per cent since I first bought it. Even worse, now I own way more of it than I did when I first bought it. Averaging down has decreased my percentage loss from 60 plus to 47 per cent, but the total dollar loss has also ballooned. Sure, my average cost is way down, but it's still under water and it'll still take a miracle to get out even. And this isn't the only dog: I have another one that is down 38 per cent, and a third one, down 20 per cent. What was I thinking?

Admittedly, none of these dogs comprises more than about 1 or 2 per cent of my portfolio, so they are small flies in the ointment. But still, I would have been better off selling them sooner, rather than adding to losing positions in the forlorn hope that they would turn around. Let's face it, "hope" is not a particularly desirable attribute in an investment. For instance, in the last few years you could have heard investors saying things like, "Gee, I hope Bre-X isn't just a bunch of salted samples," or, "I sure hope that YBM Magnex is more than a money laundry for the Russian maffiya," or "I hope the bubble doesn't burst before I can dump my Nortel."

Hope springs eternal in an investor's breast, but you need to learn to ignore it wherever possible.

One of my old friends in northern Ontario used to say that if we didn't break rules, we'd be no better than ants. Attractive as it may be to fancy ourselves as non-ant rebels, however, when it comes to investing, rules rule.

Therefore, this year I hereby resolve to make my investment losses small ones, by holding fast to the 15 per cent rule and selling any stock that is down that much from where I purchased it, no matter how much I like the company or its story (which suggests a corollary to the rule: never fall in love with a stock). It's a tough rule, and as with most New Year's resolutions, it will take some discipline to stick to it, but in the long run it will prevent a lot of pain. In fact, I'm going to dust my dogs before the end of the year, just to start 2006 with a clean slate.

This article first appeared on GlobeinvestorGOLD.com. If you'd like to profit from the insight of more than 30 financial experts and columnists, including Harry Koza — sign up for a free trial to GlobeinvestorGOLD.com

© 2007 The Globe and Mail. All rights reserved.

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