Why cut loss is an important lesson and How to cut loss.

Recently there are some stocks drops before the quarterly report. Therefore, I decided to share on why and how to cut loss. Cut loss is an important lesson which every trader must learn or go through during their trading journey. It serves as a purpose to preserve capital, you need capital to trade whenever you encounter a good stock. We want to go into the market at any time we wish.

Hope is not for stock trading

Throughout my trading experience, I notice there are several types of traders when the stocks they buy are dropping. Some traders choose to cut loss when it hits their cut loss point, however, some traders refuse to do so. Those traders refuse to cut loss always have their reasons. Reasons such as the company have good fundamental and making a profit, it has potential to make money from the projects, it has valuable assets, it is just paper loss I will gain back later, and so on. I can tell you, all the reasons pop up because of hope. Traders choose to hope and refuse to accept their mistakes, they did not realise mistakes can lead to huge losses or wipe out the whole account. In some worse cases, the company declare PN17 or delisted. Why choose hope if you already can see it is dropping or selling on the chart?

50% loss is 100% gain later

It is all back to the mental strength and understanding of trading. Let say you choose to keep the stock even it is already 50% paper loss. If the buying price was RM10,000, 50% drop means it has a value of RM5,000 only. You have to make a 100% gain to make back the 50% loss. This mathematics is simple yet many traders refuse to cut loss when the time arrives. At 50% loss, normally it takes years for stocks to go back to the price you buy and guess what, the price might continue to go up after you sell at the buying price. On the other hand, the money you stuck in the stock can actually make money easily from fixed deposit.    

Don’t average down but average up

Most of the time, traders choose to average down thinking the stock is selling cheap. I will not average down because there is a reason why a stock is selling cheaper, which you and I won’t know until the news is released. If you choose to average down, you might be buying a stock that possesses negative outlook from the market and it might plummet further down. On the other hand, a price that looks high always goes higher. A person might tell lies, price action will not tell lies.

Cut your losses small and let your winners run

“Cut your losses small and let your winners run” is easier said than done. When the time arrives to cut loss, you have to sell no matter what reasons. The objective is not to avoid losses but to minimise losses as small as possible. It separates successful investors from the rest.

Set your cut loss point

Some say “Death by a thousand stops”. Under certain circumstance, it is right because it means the person has no rule or strategy to cut loss.  A person cut loss with no rule or strategy is like a football team go to a match without tactics. You need to plan a cut loss rule, for example, 10% maximum cut loss point no matter what happens. I like 10% rule, it is the maximum loss you allow for a trade and it helps you to avoid unnecessary noise from the market. That is also a reason why I seldom check what people comment in the forum. The second method you can use is support-line, cut loss if the price close below a support line.

Conclusion

Adopt corrective action before the trade gets worsen is always a good strategy. In trading, avoiding losses is not always possible, successful traders know it and they will always try to minimise the losses. Accept mistake and learn from the mistakes takes courage. Be persistent in what you wish to achieve, that is how to be successful and no short-cut. Practice makes perfect, learn from the mistake makes you stronger.

Author: Gerald Koh