Cut your losses quickly, if trades go in the wrong direction. Ride the winners and sell the losers. If an investment is going up, don’t sell it! If an investment is losing money, get rid of it and move on! It sounds simply but is still hard to do.
Risk Management is so important and helps to save on opportunity cost. Unfortunately, private individuals ride a stock down or even worse, add unnecessarily to a bad position because they can’t admit to the fact they are wrong. While the principal investment gets smaller, they are so focused on the position that they are unable to put that money into something better. That missed chance at a better investment is the so called opportunity cost.
Solution: Set a stop loss order when you buy immediately. A stop loss will trigger a sale when the stock falls below the set level. This takes the emotion out of the decision and it will keep you from suffering big losses. Don’t set a stop loss to tight.
Recommendation: Place a trailing stop 25% below your entry price and see if this works for you. A trailing stop means, you move your stop up, when your stock goes up. Once you set your stop above your entry price, you should never produce a loss. It is a free ride to make big money.
Many investors sell a stock too early. Individuals sold a stock because they thought it had already gone up “too much” and was surely headed for a fall or a major correction? Don’t try to time the market. Instead of selling a winner, investors are better off rebalancing. This is especially important for index investors. Make sure you’re really diversified by owning a variety of funds that focus on different asset classes, including international stocks. Use the end of the year as an opportunity to rebalance your portfolio.
Remember: The trend is your friend. But if you choose to let the winner ride, make sure the stop loss orders are set and adjusted so you don’t give back all the gains.