This is actually the sister rule to the one mentioned above, and is usually just as difficult to do (even if it is very easy to define). In the same way that profitability comes from a few large winning stock trades, capital preservation so comes from avoiding the few large losers that the market will see fit to send you each year.
Setting a maximum loss point before you enter the
stock trade so you know ahead of time approximately how much you are risking on this position is pretty straight up.
You just have to have an exit price that tells you that your stock trade is a losing one you should exit before it gets any bigger. Because of gaps at the open, or limit moves in stocks we can never be 100% sure that we can get out with our maximum loss, but simply having the rules, and always sticking to them will save us from the nasty stock trades that just keep on going against our position until we have lost more than many winning stock trades can make back.
If you have a losing position that is at your maximum loss point, you should just get out of the stock trade right away. You can’t hope that it will turn around for, as it isn’t common sense.
Being that stock trades are either winners or losers, and this one is shouting ‘Loser’ at you, the chances that it will turn around and become a large winner is decidedly small.
Why would you want to risk any more money on a stock trade that has already shown itself to be a loser when you could simply close it out (accept the loss) and move on. This will leave you in a much better place financially and mentally, than holding on to your stock trade and hoping it will go back your way.
Even if it did do this, the mental energy and negative feelings from holding the losing stock trade are just not worth it. This is why you should always stick to your rules and exit a stock trade if it hits your stop point.
Never Add To A Losing Stock Trade
One of the few stock trade management rules that you should never break is ‘Never add to a losing stock trade’. Trades are split into winners and losers, and if a stock trade is a loser, the chances of it turning right around and becoming a winner are too small for you to want to risk more money on. If it actually is a winner disguised as a loser, why not wait until it shows it is a winner before you add to it.
If you do this you will notice that nearly every time the stock trade ends up hitting your stop loss and does not change direction. Sometimes the
stock trade turns around before it hits your stop and becomes a winner and you can count yourself very lucky if it does.
Sometimes the stock trade hits your stop loss and then turns around and becomes a winner and you can count yourself unlucky. Whatever happens, it is never worth adding to a loser, hoping that it will eventually be a winner. The odds of success are just too low to risk more capital in addition to the initial risk.
