How to Recover From a Big Trading Loss

To say that anxiety ruled the markets in 2022 would be an understatement: Last year, raging inflation and subsequent policy tightening from the Federal Reserve heightened market volatility. And while volatility offers plenty of opportunities for big wins, it can also result in hefty losses.

Like many investors, I know firsthand how difficult it is to rebuild confidence after a particularly stinging setback. If the past year's tough market conditions have left you with cold feet, consider this seven-point plan to help you start trading again.

Successful traders need to be able to recognize their strengths and weaknesses—and plan around them. After any loss, regardless of how big or small, I always perform a post-trade analysis to understand what to do differently next time. Did I miss something in my research? Did I let my emotions drive my decisions?

For example, I once owned a Treasury bond fund that plummeted when the Federal Reserve drastically cut interest rates during the global financial crisis of 2008–2009. I was convinced rates would rise when the recession passed, but the Fed waited until December 2015 to begin the next rate-hike cycle. Instead of cutting my losses, I continued adding to my position. I was wrong—repeatedly—and it's something I reflect on whenever I'm tempted to double down on a losing trade.

On a related note, track your trading activity to pinpoint what works well and what doesn't. I maintain a spreadsheet of every trade I've transacted dating back to 1999. In addition to basic details—including order entry and exit dates, as well as realized gains and losses—it includes a column where I jot down thoughts on what went right or wrong. The latter is probably the log's biggest value; I return to it time and again when considering similar trades or evaluating new ideas.

The silver lining of any investment loss is the ability to use it to offset capital gains (or ordinary income, up to $3,000 per year). Not only is it a tax-smart strategy, but knowing that you leveraged a loss to save on taxes can provide some consolation as well as boost morale.

You might be tempted to jump back in with both feet, but I think it's better to ease back into trading. Consider taking on smaller positions than you're used to, focusing on racking up a series of small wins to help reaffirm your trading strategy and rebuild your confidence. For example, under normal circumstances, I never risk more than 5% of my trading portfolio on a single trade; after a big loss, however, I might reduce that to 2% or 3% until I feel I'm back on solid ground.

In a similar vein, instead of purchasing, say, 100 shares of a new position, you could slowly scale up by purchasing 20 shares to start, then adding to your position anytime the price dips. The same goes for selling a winning position: I'll sometimes scale down by selling in 10- or 20-share increments if the stock is still climbing or if I've reached my threshold for a single position in my portfolio. In both cases, I'm limiting my risk—and my potential regret—by trading in pieces.

To help take some emotion out of my trading and stick to my exit plan, I like to employ limit and stop orders. As a reminder:

• Limit orders let you specify the highest share price you're willing to pay or the lowest at which you're willing to sell. In either case, the trade will occur only if it can be filled at your preferred price or better.
• Stop orders execute and become market orders only when a specific price level is reached or exceeded. This does not guarantee an execution price; the trade may occur below, at, or above the stop price.

These tools help reduce my impulse to hang on to a position for longer than I should or purchase a hot stock for more than I believe it's worth. That said, limit or stop orders do not guarantee you'll get the price you set—mainly because prices and availability of shares can change rapidly, affecting whether your order is filled.

At Schwab, I'm surrounded by insightful people who think differently about the markets than I do, and I'm constantly asking for their input. The good news is they're here for you, too. So, feel free to give them a call or stop by a branch and tell them what's on your mind. They'll be sure to put you in touch with the right professional.