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The Importance of Setting and Respecting an Exit Price

Every year, Mount Everest raises the interest of mountain climbers who attack one of the highest peaks in the world. Since the 1920s, more than 14,000 climbers have attempted the ascent and some 4,000 of them have achieved this feat. Unfortunately, nearly 300 climbers have died during their attempt. The main reasons given are lack of oxygen, falls and avalanches. However, in the case of Doug Hansen, the tragedy could have been avoided...

On May 10, 1996, the climber and members of his expedition had agreed on one point: they had to reach the summit before 2 pm, otherwise they would turn around. This deadline allowed the team to return to base camp in the light of day, but Doug Hansen still pushed his luck beyond the deadline. Although he realized his dream around 3 pm, the decision cost him his life. Why did he do it?

According to Michael Roberto, professor of Management at Bryant University, his choice was motivated by the concept of sunk costs. These represent incurred costs that are neither refundable nor recoverable. From a rational point of view, these costs should not influence decision-making, but this is easier said than done. For his conquest of the "Roof of the World", Doug Hansen accumulated three jobs to raise the $65,000 needed, not to mention the investment of time and energy for preparation. Certainly, close to the summit, these "costs" weighed very heavily when he decided to continue the climb, despite the risks he faced.

To a lesser degree, an active trader regularly faces this type of dilemma: holding an unprofitable investment or selling it. But like Doug Hansen, we tend to stay hopeful, as our investment is both financial and emotional. That is why it is essential to plan and respect an exit price for each transaction. We will then be able to limit financial losses while preserving our mental energy and reducing our level of stress, conditions that are crucial for long-term success.

To do this, I suggest using stop sale orders. For example, I buy XYZ stock at $5 and I immediately place a $4 stop sale order. If the share price falls below $4, the position will be closed automatically. Otherwise, I keep it. For those interested, Desjardins Online Brokerage regularly presents free webcasts about how to place a "stop" order. By doing so, the investor knows in advance their maximum theoretical loss (the difference between the cost of acquisition and the price of their stop sale order) and cannot justify the status quo based on the notion of sunk costs.

Without a doubt, for an active trader, the quest for consistency is a major challenge that requires effort, time, energy and discipline. Like a mountain climber, they must make informed decisions to take the value of their portfolio reach new heights!

Sources:

  • Charlie Buffet. Piège en haute montagne, Libération, April 20, 1998.
  • Charles Schwab. Choiceology with Dan Heath, Episode 3: Summit Fever, March 12, 2018.

The author

Michel Villa

Michel Villa

Speaker, stock market blogger and trading coach