With the stock market seemingly in free fall over the last few days, we thought it would be a good idea to cover what’s on most people’s minds…..losses!
I totally get it…
It can be very unsettling to see gains evaporate day after day, with seemingly no end in sight.
With that said, it’s important to approach everything in the stock market with the right frame of mind.
Here are some important elements to consider before making a decision:
1.) The goal of the original position
In order to best determine the appropriate time to cut losses, you need to first ask yourself…..why was the position taken in the first place?
Whether the answer is momentum trading, long-term position trading, hedging, etc. will have a big impact.
For example, if we’re talking momentum trading, the decision should be based almost entirely on the technicals.
A 10% drop in the stock is a commonly used metric…
Of course, this is just one option!
You can mix and match a variety of technical factors to your liking.
The outlook becomes a bit different when we get into position trading or investing.
We become less interested in what the price action is doing at that moment and more interested in the company’s fundamentals.
2.) The reason for wanting an exit
This may seem obvious at first but do not be fooled…
The mind is a tricky customer!
There is often a lot of emotional baggage at play, which can make even the most experienced traders act like complete beginners.
That is why I suggest writing down the thought process of why you want to cut losses…
This is the most effective way I’ve found to separate the emotions from the facts.
Of course, you still have to have the technical and fundamental knowledge to make quality decisions!
3.) What the capital will be used for when pulled out
It’s important to keep in mind that trading is not all about the individual position…
Money is finite, meaning that there is an opportunity cost associated with using capital for a certain trade/investment.
In other words, if you have $5000 locked up in a position, it cannot be used anywhere else!
Keep in mind that the longer the position length, the more this concept applies.
Bringing it back to our example of losses…
Even if a losing position does turn positive, you may still be missing out on better opportunities elsewhere.
That’s all for now…
Until Next Time,
-Damian