Gains and losses are inevitable when it comes to investing. However, most investors hope their wins outnumber their losses. Knowing when to buy, sell and retain a stock can mean the difference between a portfolio growing or evaporating.
â€œThere are different strategies to hedge your bets and reduce losses on a diversified stock portfolio or on an individual stock, depending on how bearish you are, and when you think the market will recover,â€ explains Judy Martel of Bankrate, an online finance resource.
Despite the importance of knowing when to cut your losses, many stock traders hold onto losing stocks for too long, damaging their portfolios in a very real and sometimes long-term way. International institutional investment consultant Wayne Wile warns investors to avoid sentimental attachment to stocks. â€œToo often investors hold onto stocks for too long due to emotional attachment or unwarranted optimism,â€ says Wile. â€œKnowing how to separate this attachment in order to unemotionally and realistically assess a situation is my key recommendation for investor success.â€
Knowing how to stop oneâ€™s losses as a stock trader is clearly very important. These five guidance points can help to do just that:
1. Have an exit strategy
It is imperative that stock traders have a planned exit strategy for every stock they purchase. â€œThe exit plan may have a threshold that indicates when you sell or may be dependent on the duration of time the stock is owned,â€ notes Wayne Wile.
Either way, the exit strategy for each stock should be clear and ideally documented in some way.
2. Stick to the exit strategy
Creating an exit goal is only the first step in stopping losses. Stringently adhering to the strategy implemented is also critical for savvy investors. ChartAdvisor, a website dedicated to stock investment tips, advises setting realistic target exit prices for all stocks. â€œWe lock in high returns while the stock is high, and we get out before the market has a chance to change its mind.â€
3. Consider short selling
Advanced investors often short sell once the price of a stock falls below resistance levels. Short selling allows one to invest in stocks even when they think that their share price will decrease.
â€œShort selling is often used for hedging,â€ explains Wayne Wile. â€œHedgers use the strategy to protect gains or mitigate losses in a portfolio.â€
Aptly named hedge funds are among the most active short sellers and often use short positions in select stocks or sectors to hedge their long positions in other stocks.
4. Implementing a trailing stop strategy
Trailing stops is one of the tried and true methods of loss mitigation. The trailing stop maintains a stop-loss order at a precise percentage below the market price and is used to prevent significant losses. However, many investors donâ€™t know where to set the threshold for trailing stops. Dr. Steve Sjuggerud, author of the Daily Wealth Blog, suggests a 25 percent trailing stop that lets investors get out before too much damage is done to their portfolio.
â€œI can tell you from experience, this is never easy… When I sell something at a loss, I am proud of myself for sticking with my strategy. But it is never a â€˜happyâ€™ day,â€ says Sjuggerud. â€œIt never feels natural. But it is right.â€
5. Diligently research stocks before they are acquired
This last tip is one of the most important. Thoroughly researching a stock before purchasing it should help a stock trader be able to gauge the risk associated with the stock and whether that sort of risk is acceptable. â€œThe best investors have completed their own thorough due diligence and are well informed,â€ says Wayne Wile. â€œThese types of investors are also less likely to be spooked from a minor loss or dip in stocks because they are versed on the history of the stock.â€
Taking the time to ensure stocks match an investor’s comfort level and expectations will prevent headaches and losses down the road.
Many fortunes are made and lost on the stock market annually. For novice and seasoned investors alike, having a well-crafted exit strategy can ensure small losses donâ€™t destroy a portfolio and can help make the most of stock options investments.