The Secret To Market Success
Do you know the secret to having success in the stock market? If you said that the secret is knowing which stocks will be the winning performers, you are wrong. The real secret is being able to recognize a losing trade and cut your losses early.
The Real Secret
It would be nice if we were all able to select a winning trade each and every time. Unfortunately nobody is right all of the time, not even the high-paid professional traders. Therefore the real secret to market success is knowing how to minimize your losses and preserve capital for the next trade.
Bernard Baruch once said:
Even being right three or four times out of 10 should yield a person a fortune if they have the sense to cut losses quickly.
Think about that for a minute. You don’t need to be right on each and every trade to make money in the stock market if you understand the importance of minimizing your losing trades.
Eliminate The Emotion
It is human nature to resist admitting a mistake and many stock traders become emotionally attached to a particular stock. Be honest with yourself, how many times have you purchased a stock that has decreased in price and you keep telling yourself that it will come back? Trust me, I know because I have done the same thing.
When I first began to learn about technical analysis and started to become a little more active with my trading, I learned the concept of using stop-loss orders to minimize my losses. Initially I would use “mental” stop-loss orders, meaning I knew what price that I should sell the stock if it were to drop but I didn’t set a firm order until that happened.
Unfortunately I ran into a few trades where the price did drop and as it hit my limit where I should have been selling with my mental stop-loss order, I tried to rationalize that the stock would come back and I kept holding the stock. As I am sure you can guess, the stock price continued to drop and I ended up selling the position later for a larger loss.
When you purchase a stock, you will be doing yourself a huge favor by setting your stop-loss order immediately after the purchase. The reason that you want to do this is that you eliminate the emotional aspects of selling a stock that is losing money. Do not let your pride stand in the way of admitting a mistake, act quickly and cut your losses while they are still small.
Setting Your Limit
What is a good number to use as your stop-loss trigger? As with most things in life, different people will use different values but in reading the books of William O’Neil, founder of Investor’s Business Daily, I have learned to set my limit at a 8% loss.
When a stock falls 8% below my purchase price, I sell the stock and preserve my capital for the next trade. Sure, there have been times where I have sold a stock only to see it rise right back up a day or two later. However, more times than not the stock continues to drop and not selling would only put me in a deeper hole.
Consider the following, if you buy a stock at $100 per share and it drops 20% to $80 per share, are you aware that you now need a 25% gain just to get back to the $100 purchase price? How about a stock that drops 50%? In that case you now need a gain of 100% just to get even. That is not a recipe for long-term success in trading stocks.
If you are buying stocks at the proper purchase points, you can be pretty certain that there is something wrong with the stock if it is dropping to your 8% stop-loss order so it is best to cut your losses and live to trade another day.
Use This Secret For Success
By now you can likely see the importance of cutting losses early before they have a chance to become large losses. Learning how to use the stop-loss order effectively will allow you to eliminate the emotion from your stock trades, which is often one of the biggest hurdles to becoming a successful stock trader.
Don’t allow your stubborness of admitting a mistake cost you more money in the long run. Remember what Bernard Baruch said regarding how often you need to be right on your stock trades if you learn to cut your losses early, three or four times out of ten doesn’t seem quite so daunting now does it?