Most people acknowledge that losses will happen regardless of the type of business venture. A light bulb manufacturer knows that two out of three hundred bulbs will break. A fruit dealer knows that two out of every one hundred apples will rot. Losses per se don’t bother them; unexpected losses and losing on balance does. Acknowledging that losses are part of business is one thing, taking and accepting those losses in the markets is something else entirely. In the markets, people tend to have difficulty actively (as opposed to passively as in the case of the fruit dealer and bulb manufacturer) taking losses (i.e., accepting and controlling losses so that the business venture itself doesn’t become a loser). This is because all losses are treated as failure; in every other area of our lives, the word loss has negative connotations. People tend to regard the word loss, wrong, bad, and failure as the same; and win, right, good success as the same. For instance, we lose points for wrong answers on tests in school. Likewise, when we lose money in the market we think we must have been wrong!

. . . What I Learned Losing A Million Dollars by Jim Paul and Brendan Moynihan

Everyone knows how to win. Few know how to lose. Yet the secret to making money in the various markets is knowing how to lose. How to control your losses. In the book Warren Buffet calls the best book ever written on investing, namely Ben Graham’s TheIntelligentInvestor, it notes, “The essence of portfolio management is the management of risks, not the management of returns. All good portfolio management begins and ends with this premise.” My father put it much more succinctly when he said, “Son, if you manage the downside in a portfolio, and avoid the big loss, the upside takes care of itself.” Indeed, knowing how to lose, how to control your losses is the key to successful investing. Listen to the pros:

I’m always thinking about losing money as opposed to making money. Don’t focus on making money, focus on protecting what you have.

– Paul Tudor Jones

The majority of unskilled investors stubbornly hold on to their losses when the losses are small and reasonable. They could get out cheaply, but being emotionally involved and human, they keep waiting and hoping until their loss gets much bigger and that costs them dearly.

– William O’Neil

One investor’s two rules of investing: 1) Never lose money 2) Never forget rule number 1.

– Warren Buffett

All of these professional investors have different market philosophies. They have contradictory strategies for making money. Some are traders; some are value players; some are growth-stock advocates, other are emerging-growth seekers, etc. But all of their messages are clear – learning how not to lose money is more important than learning how to make money! And, in learning how not to lose money you have to evaluate risk. Indeed, “The essence of portfolio management is the management of risks, not the management of returns!”