By MoneyMorning.com.au
How often do you reckon a successful stock trader gets it right? 60%, 70%, 80% of the time?
Not a chance!
Most stock market traders don’t get anything near that sort of hit rate. At least not the stock traders I talk to. Many of the best traders have a hit rate of well under 50%. Sometimes as low as 20%!
But they still make money overall.
This all comes down to what’s probably the most important lesson you can learn as a stock market trader. That is: maximise your winners and minimise your losers.
Even if you don’t consider yourself a stock trader, keep reading. This is for long-term investors, too. In my experience, many stock market trading concepts can be incredibly useful for your long-term investment approach. Especially this one…
Imagine you’re learning to ski. You’re descending nervously down the slope when things start to go wrong. You’re building up speed and you’re going too fast to put in a turn. That’s when most sensible novices sit down – a self-induced fall you might call it. If not, you end up gathering pace and setting yourself up for an almighty wipe-out.
That’s kind of what I’m talking about here. When your losses start to gather pace, you need to get out of the trade. A calculated crash – and minimised loss – means you can get up and have another go.
In terms of stock market trading, what we’re talking about is setting relatively tight stop-losses. A stop-loss is basically an instruction with your stockbroker to quit your trade if it hits a predetermined level. It quite literally ‘stops’ your loss from escalating.
My colleague John C Burford often refers to his 3% rule. Never put more than 3% of your cash at risk with any one stock market trade. Work out where that loss is and place your stop there.
The only thing I’d add is that your stop should also relate to the stock’s volatility and trading range.
Now clearly such a tight wealth preservation strategy could trigger a lot of stop-losses. As a successful stock trader, you’re going to have to accept not just the occasional loss, but a lot of them.
That’s why most investors don’t make for good traders. Most can’t accept that in this game you never progress further than the ‘novice’ level. The most common shortcoming for a stock trader is that he thinks he’s an expert. He’s not going to sit down before he falls down – and he sets himself up for a serious wipe-out.
But of course you’re never going to get rich by just cashing in losses…
To make up for your losing stock trades, you’re going to have to make sure you squeeze some serious profits out of your winners. This is tougher than it sounds.
With a stock moving up, emotions run high. There’s a very real danger of getting trigger happy… glued to your monitor, with your hand on the mouse, it’s all too easy to snatch a quick profit. “You’ll never go broke cashing in a profit” is dangerous advice.
What you want to do is make the most of the momentum. Ride your winning trades until you’re confident the trend has reached the end. A trailing stop-loss could be great way of doing that. You keep moving your stop-loss up as the price goes up, selling once the stock drops a certain amount below its high.
The point is, minimise your losses and let your winners run.
Bengt Saelensminde
Contributing Editor, Money Morning (UK)
Publisher’s Note: This is an edited version of an article that first appeared in Money Morning (UK).
Minimising losses and letting the winners run is part of what makes Murray Dawes a successful trader. Remember to check out Murray’s latest free stock market update video on YouTube by clicking this stock market update link.
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