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You may have heard the expression “cut your losses early” before.
This is probably the most profound wisdom for stock investors. The
table below will illustrate the reason behind this insight.
The table shows that it
is exponentially harder to recover from the decline in stock
value. For example:
- If a stock loses 10% of its value, it only takes a gain
of 11% to make up the loss.
- If a stock loses 20% of its value, it takes more effort at a
gain of 25% to make up the loss.
- If a stock loses 50% of its value, it takes improbable gain
of 100% to make up the loss.
- If a stock loses 90% of its value, it takes impossible gain
of 900% to make up the loss.
This is why stop-loss order of 10-20% below
the price at which you bought is recommended. It takes enormous
effort to recover from anything greater than that.
Note: my trading strategy cuts losses at -5%
for long positions and for swing positions as soon the market trends
sideways (market consolidation).
There is absolutely no guarantee that a stock
will ever come back. In fact, waiting to break even - the point at
which profit equals losses - can seriously erode your returns.
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