What do you expect when you buy a stock? We expect the stock price to go up so that we can sell at higher price than we originally bought them and take the profits. But many times things turn out not as we planned. What happens if the stock price does not go up but instead go down? It goes down 5%, 10%, 15%...50%.... If you don't cut you losses, you will lose your hard-earned money.
You may face financial difficulty if you buy stocks on margin. This is the actual situation during the last few years when NASDAQ plunged from the peak of 5000+ points to 1000+ points. Imagine if you put your stop losses in place, normally about 10%, you are out of the wood and just lost 10% of your money.
Nobody wants to sell a stock at a loss; it is a loser feeling. I have the same feeling many years back. I bought the stock at $18.00 and you ask me to sell at $16.20, no way! Yes, this is exactly what most investor would respond.
When stock market crashes and if you don't stop loss at $16.20, you will be watching your stock plunging from $16.20 to $12.00, to $8.00, to $4.50 and 40 cents. This is why so many investors lose money, houses and cars. By applying this simple rule of cutting your losses, you can protect your capital from further shrinking.
This sounds simple but it works ALL THE TIME! Stop loss is not only a rule. It is a stock market principle. Do you know that there are only two types of investor in the market, the donor and the collector? Which type are you? Do you want to join in the collector group? If the answer is yes, don't act emotionally, and apply the stop loss rule!
It is not easy to be the collectors. Even the fund managers are not able to be collectors. Sometimes they are donors in a big way. Do you think fund managers out there really make money for you? Their job is just to beat the index. If the index drops 30% and their funds drop by 25%, then they consider themselves as heroes. For fund managers, there are many rules and regulations that restrict them from cutting losses. But as an individual investor, you can.
Stop loss is just like buying house fire insurance. You pay a small premium to protect your house (capital). You will get paid in full amount if your house is burned down (Market Crash). Similarly in stock market, you just pay small premium (10%) to protect your 90% capital. Protect your capital and you can come back any time. There are so many good stocks and so many opportunities out there.
As a successful investor, you should not have emotion with your stock. They are just business products helping you making money. Don't fall in love with them. When time comes to cut loss, just sell them off without emotion.
Many investors lose money in the market because they don't want to sell their favorite stocks. They think the stock price will bounce back eventually. If you let your stock goes down 50%, you will need the stock to climb back 100% just to break even. How often stocks double in price??? Yes, sometimes the stock price will come back, but most of the times the stock price never rebound. Yes, I mean never. So, why take the risk betting and hoping the stock price will come back. Just take a small loss and move on to other stocks.
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