Managing Loss
Dr. Invest

The real title is managing gains, not losses. I can't think of anyone who bought a stock expecting to lose money. And that is the key, you should never loose money. YOU WILL LOSE MONEY, but the objective is to manage your loss.

You are psychologically designed to WIN! This is expressed in the characteristic of competitiveness. Imagine a hungry cave man who just caught a glimpse of tonight's meal. He is not wired to walk away or give up. His brain is wired to win. You may not know it, but this primitive motivation is right there in you.

When you buy stock, the pursuit of prey begins. You can't imagine yourself losing, so even when your stock shrinks in value, you are hopeful that it will gain value and you will walk away with the prize. Although beneficial to the cave man, this kind of thinking will lose you tons of money in the stock market.

The way you overcome this little glitch in thinking is to PLAN. You have to plan against your way of thinking if you are to consistently make money in the stock market. By planning, you manage your loss. So I'm not going to talk about "stock selection" or "purchase targets" in this blog, only about how to plan against yourself so as to manage your loss.

When you are ready to buy a stock, you need to know more than the price. You need to have a PLAN FOR HOW MUCH YOU WANT TO LOSE. Yes, I know this sounds strange, but trust me. See, you will have likely considered how much your going to make off this trade, but I'd bet you had not considered how much you were willing to lose.

So if you are investing $10,000, how much are you willing to lose? 1% is $100; 2% is $200; 3% is $300. If you are buying a stock, certain that it will rise in value, are you also prepared to let it go? If you buy $10,000 of ABCstock, you need to immediately put a STOP SELL of 3% on ABCstock. If things go as planned, ABCstock will grow 5% and you will move your STOP SELL but if ABCstock declines in value, you will still make 2%.

Earlier in 2011, I purchase (HK) Petrohawk. It grew 26% and then in March, declined below my STOP SELL that was set at 3% below the price of (HK). When (HK) declined, the STOP SELL was triggered and my earnings from (HK) was 23%. When I later saw (HK) recover, I doubled my investment in (HK), setting my STOP SELL 3% below my purchase price. As (HK) grew in value, I moved my STOP SELL from time to time to be 3% behind the closing price of (HK). (BHP) Billington bought out (HK) and BHP tendered an offer for my HK stock. The gain was 46%. Total gain for money invested in (HK) at the end of July was 72% return.

In mid-July, I had purchased CRZO, an oil stock. The reports were excellent, but oil prices were going down. I placed a STOP SELL on CRZO and in short order, CRZO sold and I lost $150. I can't even tell you how much that hurt my cave man brain; but had CRZO not sold, my loss as of today would have been $540. I managed my loss because I used a STOP SELL, and it was executed automatically.

Don't get STOP SELL confused with STOP LIMIT. Using a STOP LIMIT, you can sell a stock at an exact price, for instance $19.92. If you use a STOP SELL, the stock sells at the best available market price for your stock. So if you say, sell at $20, the best market price might be $19.96. So you could get a lower price for your stock than where your STOP was set. If you use the STOP LIMIT and say, sell at $20, they have to sell it to you at $20. Here's the problem. The market doesn't always move in a linear way, for example: 1, 2, 3, 4, 5. But most of the time moves in a non-linear way like: 1, 4, 8, 9. So if you set a STOP LIMIT at $19.29, but the price of the stock was never bid for at $19.29, but rather $19.23, your stock would never sell. The market would go down and your STOP LIMIT would be setting there untriggered, and you suffering losses. (I learned about this by experience.) So even though you might lose a few pennies per stock, use the STOP SELL.

One last secret to buying and selling triggers. You can use a STOP BUY as well as a STOP SELL. Without being in front of your computer to make a BUY, you can enter a request to BUY from your broker when the stock reaches a certain price. This is called a STOP BUY.

My suggestion, if you don't have a broker, is to open an account with OPTIONSHOUSE.COM where you can practice with a VIRTUAL ACCOUNT and learn about the Trading Desk and take some of the Trading Courses. Do remember that they want you to make as many trades as possible so they can make money. Learn, but just don't play the game the way they want you to.

If you will have a PLAN to MANAGE LOSS by using a STOP SELL when your purchase a stock, set at 3% (or whatever you want to lose), you can limit your loss and if the stock gains, you can advance your STOP SELL behind the closing price of the stock to guarantee your gains.

(Note: The above article is not for financial advice but soley for entertainment purposes)