Dump Your Losers or Double Down?

Face it: The market blind-sided you.

For years, stocks went nearly straight up, with only a few hiccups along the way. So as investors peruse their brokerage statements lately, many simply aren't equipped to deal with something they've never seen before: losses of 30%, 40%, and even 50% or more on some of their stocks.

Even the most conservative investors have seen firsthand the return of risk to the risk-reward equation of stocks. As of yesterday, just one of the 30 Dow stocks -- Wal-Mart (NYSE:WMT) -- was up for the year. Even some of the "lucky" stocks that lost less than the average have taken fairly big hits:

Meanwhile, even blue-chip stocks haven't avoided getting cut in half:

And it's not just a one-year phenomenon. Long-term holders of many stocks have seen years of gains evaporate in a matter of months, and now are sitting on losses. The mass dumping of stocks have many investors questioning their entire investing strategies, making them wonder if even relatively safe stocks are safe enough for their nest egg.

If you're seeing companies in your portfolio suffer big price drops, what should you do? It's too easy to jump straight to a trade: either buying more shares, or getting rid of them before you suffer more losses. But before you act, think. Here's a quick guide of things to consider.

1. Go back to the beginning.
To evaluate whether you should still own a stock, you first have to know why you bought it in the first place. That's why it's so important to keep a record of your thought process for choosing the stocks in your portfolio. It not only forces you to have solid, substantial reasons for making your initial investment -- it also gives you a guide to fall back on, a checkpoint from which you can get your bearings no matter what happens in the future.

In simplest terms, if the reason your stock has declined is totally unrelated to the reasons why you bought it, then you should feel comfortable holding on. On the other hand, if something fundamental to your original decision is now gone, then you should seriously consider selling -- even at a steep loss.

2. Look forward.
Right now, the major source of uncertainty in the markets is how hard it is to predict the future. Fears of an imminent collapse of the world financial system still haven't gone away, despite some strong bounces in the markets this week.

Nevertheless, stock prices are forward-looking. Despite Wall Street's emphasis on how much a company will earn next quarter or next year, long-term earnings and growth prospects still make up the lion's share of valuation by nearly any measure.

So, even when the future's hazy, you still need to figure out how you think a company will do -- and how your assessment compares to other people's expectations. If you have good reason to believe a company will thrive in a recession, then you won't want to sell out cheap. On the other hand, if everyone else thinks things are rosy but you're not so sure, that stock's a good candidate to replace with something more promising.

3. Don't anchor.
Finally, try to take an independent look at what your stocks are worth, without thinking about what you paid for them. It's tempting to hang onto a stock if it's trading below your entry price. That's called anchoring -- and if you hold on waiting for another dollar or two, you may miss what turns out to be your last chance to sell -- and see the rest of your investment disappear.

Nothing's harder than trying to figure out where your investing decisions went wrong and how to deal with losses. But once you master the art of dealing with losing stocks, you'll have learned a vital lesson that will serve you well for the rest of your investing career.

For more on investing in today's markets, read about:

• What you should do if the Dow hits 7,500.
• Why now is the time to invest.
• Are you ready for another 25% drop?