Taking A Cut

In stock market trading, one school of thought is that the best defence against a declining position is to have a hard and fast sell rule. I was reading on the Yahoo Finance page today:

Even if you feel sure that your sliding stock will eventually rebound, admit two things. First, the market's direction cannot be predicted; second, you could be wrong about the stock.

Those two facts are why the safest route is to sell any stock that falls 7% or 8% from your purchase price. Follow this rule without exception and in any market condition.

If you sell to cut your losses short and the stock does rebound, you can jump back into it when a new buying area forms. The important part is that your capital lives to fight another day.

Rather than wring your hands and hope for your stock to recover, raise cash and search for leading stocks as they break out of proper bases.

Keep in mind that the larger your loss, the more the stock has to work to erase its loss.

A drop of 25% requires a gain of 33% to break even. If you hang in for a 50% loss, your stock must turn and rise 100%. But if you pull the rip cord at 7%, you only need to make 7.5% on your next investment to rebuild your initial capital.

While this strategy might be more useful in the slower moving longer-term sports markets, it is still of value in the typical short-term individual match markets.

Probably the hardest lesson for a trader to learn is the importance of cutting losses short, but it is essential that this lesson is learned. Preserve that capital, and you live to fight another day. Let the loss run, and your investment becomes a gamble. Your capital is at risk of serious damage.

I used to hate it when I would have to go red all over, especially if the market reversed and my original position became profitable, but now I accept it as part of the game. It’s the right thing to do, I tell myself.

Although most of us are better able to predict the market direction in a sports market than the stock market, not one of us will be right all the time. The trick is to be right more often than the odds suggest, in other words, to find value.