Investment Success Means Cutting Losses
If you want to become a successful investor online, you need to learn to cut your losses with each and every trade that goes bad. Did you know that some of the best traders in the world don’t even win 50% of the time? You don’t have to be right every trade to make money investing online, but you do have to be smart.
Stock Trading Tip 3
Cut your losses always to a maximum of 5 - 8% to prevent portfolio disaster.
By cutting your losses 5 - 8% you will be limiting the bleeding on those trades that just didn’t go right. The math speaks for itself because if you are down let’s say 30% on one stock, then you will need to do substantial growth to make it back. Let’s take an example:
Stock XYZ
Purchase Price: $100
Last Price: $80
So, in this case we are down 20% on stock XYZ, and to make our money back we need the stock to move back to $100. To do that though the stock will have to move up 25%, not 20%. Take that one stop further and let’s say Stock XYZ is at $50 a share and we are down 50%, to get our money back the stock will have to double and move up 100%.
By maximizing our losses and letting our runners run, we can make money with a lower success ratio.
What this means is that if we ALWAYS maximize our losses to 5% per trade (which can be done very simply through stop loss orders), and we always sell our stocks after they go up 20%, we only need to be right 25% of the time to run a profitable portfolio.
How is this possible? Well, let’s take an example and say we have $10,000 to invest, and we buy 4 different stocks each with $2,500. We’ll say that 3 are losses that we were stopped out at 5%, and one was a winner for 20% where we sold:
- $2,500 x 5% Loss = - $125
- $2,500 x 5% Loss = - $125
- $2,500 x 5% Loss = - $125
- $2,500 x 20% Gain = + $500
End Result, + $125.
You can play with this math any way you like, but it will come up the same each and every time. If you can get into the habit of maximizing your losses and letting your runners run, you can and will be a great at online stock trading.
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Preach it brother!!
I talk to numerous competent professionals who have learned the hard way. You must always have an exit strategy if things don’t go the way you expect. If you don’t, you are asking to be carried off the field on your shield. I nearly got fired the first time I began to manage money for our firm because i didn’t have proper risk control. I learned that lesson and will never let a position or several positions put me in that place again.
Thanks for the important reminder - if anyone is out there doubting this truth - take it to heart!
lol, preached. I agree and learned the hard way myself, luckily it was on my own money and didn’t almost get me canned
??: . Is your blog new?
yeah - just getting it up and running. I find it helps me to express my thoughts and come up with clearer more succinct reasons for my positions and I enjoy the comments that help me think through points i may not have pondered yet.
Any tips for a newbie like me?
On blogging? email me and we’ll talk
I find a great way to set stop losses is with the Dr. Alex Elder method of money management (book: come into my trading room). His philosophy was to never bet more than 2% of your portfolio value in a single trade. So if you have a $100,000 portfolio, you would never let your stop loss to be greater than $2,000.
To make it more clear: If the stock is trading @ $10 and you notice that support is $2 away (where you set your stop), then you can trade a max of 1000 shares ($2000/$2). Personally, I don’t like to risk anymore than 1% of my trading portfolio.
FT
that can get tricky though I think from personal experience. It really depends on what stocks you are buying, when, and at what price. For instance if a stock gaps up 5% and you buy in at the open, there is a very high probability of the stock retracting 1 - 2% intraday before climbing back up, which then kicks you out of your position. Really for it to work you have to buy the perfect stock, that simply never will fall below your buy point, thats tough.
Hey Blain,
I don’t think I explained it properly. If you set your stop @ 8% of a $10 stock, that means that you can let your stock fall to $9.20 before selling (risking $0.80/share). ACcording to Elder, if you have a $10,000 portfolio, you can risk up to 2% of it/trade which is $200, which in this case means you can purchase a maximum $200/0.80 = 250 shares without risking more than 2% of your portfolio.
FT
ahhhh, ok on the same page now. Thanks for the extra explanation, that actually makes a lot of sense
Yes, I should have explained that it is more of a money management technique that can incorporate your 6-8% stop loss strategy.
[...] your portfolio diversification works, and it is a matter of managing it with a stop loss and cutting your losses. Do you own 5 stocks or 50 right now? Could you sell some stocks that are not up to [...]
I think using the R-multiple method is the best way to measure risk on a position to cut losses.
Essentially 1R = amount of money you expect to gain on the trade at minimum, 2R = double that
The goal is to keep your losses no worse than -1R per round-trip trade. Ideally your profits are able to run producing multiple R gains on the winning ones.