Investing--IBD: "Cut Losses To Preserve Confidence, Capital"
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>>>Thursday, August 10, 2000
Cut Losses To Preserve Confidence, Capital
By David Saito-Chung
Investor's Business Daily
A small loss is easier to take than a big one. That might seem obvious, but it's crucial in investing.
Smaller losses leave you with more capital with which to find a new good stock. Keeping losses small protects you long-term if you have a string of bad picks.
The reasons don't stop there. Letting a small loss balloon into a big one can sap your confidence and wreck your mental focus.
Say you buy a stock thinking it will double in price. It falls 7%-8% below your buy point, triggering your sell-stop rule. You hold on, thinking it will recover. Instead, the stock falls 25%, then 50%, shaking you out of the stock.
You might dwell on that loss for days, weeks, even months. You might watch the stock to see if it recovers. You might rant online about that bad stock.
If you do, you'll take time away from searching for other stocks that may become big winners. You'll also have less time to analyze the market.
A big loss might make you think that investing in stocks isn't for you. Truth is, the market goes through CYCLES and always offers huge opportunities for those who are ready to take them. But it never waits for those who are scared or peeved about their past losses.
After a long or sharp decline, the market can turn upward on a dime. Remember, it takes just four to seven days for the market to show if it is launching a brand-new rally.
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The market slumped from the spring of 1981 to the summer of 1982, the longest bear market since the 1980s. The Dow industrial average sank 25% over that period, the Nasdaq 29%.
On Aug. 13, 1982, the Dow ended an eight-day losing streak by gaining 1.9% in volume well below its average over the past 50 days (point 1 in accompanying graphic.) Two days later, the Dow vaulted 4.9% - in volume much heavier than the previous day. On Aug. 20 - the rally's sixth day - the blue chip gauge roared 3.7% on higher volume, (point 2) a classic follow-through. Home building, toy, car, military electronics and generic drug stocks led the way.
Around the same time, the Nasdaq began a new rally. Over seven days, the index leapt 8%, gapping higher in two sessions.
It's not easy to take losses. In school, we're trained to think that only a score of 90% is worthy of an A. But you don't have to be right 90% of the time to win in the market. Even if you make three losses of 7% to 8%, you can cover your losses and still have a profit by picking a stock that rises 30% or more.
It takes time and experience to see how this works. At seminars held by the International Institute of Trading Mastery in Cary, N.C., participants practice taking a series of small losses and then getting a big winner. They gradually gain confidence in cutting losses short and letting winners ride.
"What typically happens is that you get three, four losses in a row, and then you feel like giving up the whole system," said Van Tharp, head of the institute.<<< |
