I’ve a close friend. Let's name him John.
And he's currently in trouble.
He owes money with a ‘loanshark.’ His debt spiraled to $300,000 in twenty-four hours.
The pitfall began during his first and last visit to the casino.
John won few rounds at the Black Jack table. Some called him ‘lucky.’
So, he continued to roll bigger bets. But he suffered losses.
It didn’t matter to him. He felt the Gods of Luck would bless him.
That was the first of the many red flags on that day.
John realized that his capital was drying up. But he couldn’t stop himself. He took quick cash loans from a notorious moneylender.
The winning streak that he craved didn’t materialize. Instead, his losses became bigger. In the end, his net worth was in the red!
When midnight struck, John looked dazed.
Questions and fear started to cloud John's mind.
How was he going to repay the loans and interests? How was he going to ask for a time extension for delayed payments? How will he explain to his wife about the mess he made?
He's screwed big time.
So how does John's trouble relate to the next trading lesson? Continue reading, my friend.
In 2007, I began to learn how to invest. Since Warren Buffett was my idol, I bought many books about his ‘buy-and-hold' techniques.
I felt determined to try his investment strategy. So I did what any novice investor would do. I poured all my life savings into favorite stocks.
Things went okay at the start. I was receiving dividends every quarter.
But in 2008, the financial crisis hit Wall Street. Everyone faced the Great Depression for the next eighteen months.
When I heard the breaking news, I shrugged it off. I thought the market would bounce stronger.
So, I held onto my stocks. I had faith in my portfolio.
“This episode is only a phase. And it'll pass.”
In fact, I bought more shares.
“Buy low, sell high.”
So for the next several months, the market dipped lower. So did my stocks.
I was hesitant to sell my underperforming stocks.
But I couldn’t sleep well at night.
Two weeks later, I decided to throw the towel.
I sold all my shares at losses that average around 60%.
Although it was a big blow to my confidence and wallet, it saved me from sleepless nights and worried.
Set your ego aside so that you can take a small loss and continue to invest the next day. Cutting losses prevent you from suffering a steep price drop that is hard to recover.
Consider the math. Say you buy a stock at 50. For whatever reason, it drops 10% to 45 during the next few days. You unload it and move on immediately. To reclaim that loss, make an 11% gain on your next buy with your remaining capital.
What if you're stubborn and keep your stocks?
You're sure the stock will snap back. Your research convinces you it's worth $ 100, so why get scared by a minor setback?
Here's the issue.
The market also doesn't care who you are, what you think of stock.
To break even from a 25% loss, now you need a 33% gain. That is much tougher to come by than that 11%.
What if your stock price cut in half to 25? To recover a 50% loss will need a 100% gain.
Ask yourself. How many stocks did you pick that doubled in price?
Successful investors take small losses and look for the next potential winner.
Leave your emotions behind. Cutting losses will help keep your head clear when it's time to return to the market. Remember that buying opportunities occur after the bear markets end. It's when the major stock averages have declined 20% or more.
That's when most investors who haven't cut their losses are regretting. They also don't want to involved anymore. It's not easy to think straight after losing thousands of dollars. But the market always recovers.
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