We’ve all lost money share trading. And it stands to reason that IF ONLY you could stop losing money, you would actually make a lot more.
It’s painfully obvious. But despite that the vast majority of traders DO NOT set a Stop-Loss on their trades.
It’s like jumping out of the international Space Station without your tether, literally nothing is stopping you from floating off into the vastness of space.
A stop-loss is designed to stop you floating into a black hole of loss.
You can make more money by losing less, but exactly how much more, and how much would you need to reduce those losses to make a difference?
Let’s break down
When you lose money trading, you need a greater percentage gain to break even.
For example, if a position declines by 50%, say from $40 to $20, that stock will have to rise by 100 percent (from $20 to $40) to get back to even.
That’s worth repeating:
A 50 percent decline in price requires a double to break even!
What happens if you keep your losses relatively small?
By keeping your losses small, you preserve your hard-earned capital for future investments.
The question is though, how do you limit your losses?
And the answer is simple, use a Stop-Loss. But what’s a stop-loss I hear you ask?
Great question, glad you asked…
A stop-loss is…
An order placed with a broker to sell once the stock reaches a certain price.
A stop-loss is designed to limit an investor’s loss on a security position. Setting a stop-loss order for 10% below the price at which you bought the stock will limit your loss to 10%.
For example, let’s say you just purchased Microsoft at $20 per share. Right after buying the stock you enter a stop-loss order for $18. If the stock falls below $18, your shares will then be sold at the prevailing market price.
The advantage of a stop-loss order is you don’t have to monitor how a stock is performing daily. This convenience is especially handy when you are on vacation or in a situation that prevents you from watching your stocks for an extended period.
The disadvantage is that a short-term fluctuation in a stock’s price could activate the stop price.
The key is picking a stop-loss percentage that allows a stock to fluctuate day to day while preventing as much downside risk as possible. Setting a 4% stop loss on a stock that has a history of fluctuating 8% or more in a week is not the best strategy.
The lesson here is never to permit yourself to lose an amount of money that would jeopardise your account. The larger the loss is, the more difficult it is to recover from it.
Set an absolute maximum line in the sand of no more than 10 percent to the downside.
If you can’t be correct with a 10% cushion for normal price fluctuation, you have a different problem to address. Either your selection criteria or timing are flawed or the overall market is hostile and your money should be parked safely on the sidelines.
The Bottom Line
Capping your losses can have a dramatic effect on your returns.
The hypothetical table below shows how this strategy can turn a double-digit loss in a portfolio into a gain of more than +70%
Just PURELY controlling your losses will change your trading almost OVERNIGHT.
Compound returns without a stop loss strategy -12.05%
Compound returns WITH a 10% stop loss strategy +79.89%
If you’re experiencing losses and you are trading WITHOUT a Stop-Loss, this is definitely going to have and impact on your results.
But a bad investment, is still a bad investment, but you will ONLY ever lose 10%.
Now you know how limiting your losses can drastically increase your returns, but what do you need to do before you set a Stop-Loss?
What you can do now
Buying the right stocks in the first place is a great place to start!
Here’s HOW you can solve that problem for just $1!