Common investment mistake No 2 & 3 By Darren Winters
LETTING YOUR LOSES RUN, (AND CUTTING YOUR PROFITS SHORT)
Lets tackle those run away loses first. Come on, own up, how many of you have bought shares that have started to drop and you have just held on to them as they dropped further and further. When I first started out, I initially fell into the same trap –
you know what I’m talking about - you have just brought the shares and maybe after an initial increase they start to drop. What do you say to yourself?: “Well the share has only dropped a bit, it’s a great share and I bought it at a good price, it’s got to be about to go up” - 2 months later and a further 20% drop in the share price: “If its gone down this far, it can’t go much further, it really is a great price now, it’s got to be ready to turn” - 6 months later and another 40% drop in share price: “Well it’s too cheap to be worth selling now, and my stock broker told me that it is for the long term any way – maybe I should buy some more?” 10 months later and the company is declared bankrupt ... maybe!
How to Avoid: Letting your loses run, and cutting your profits short
There is no reason that you should ever find yourself in this situation, if you just follow this one basic rule: As soon as you buy a share always place a sell stop order. For those of you who are new investors, what does this mean? A sell stop is simply an automatic order that you give to your stock broker (a real person by telephone or through the internet online) to sell your shares if they ever drop below a certain level that you set. Now you might be thinking to yourself “Well surely that means that if my shares are sold only when they drop below a certain level that guarantees that I lose money?” Well YES and NO. If your shares price drops far enough below the price you bought it at, you will lose money, but only a limited amount. However if your share goes up in price (after doing your fundamental checks / basic chart reading mentioned above, this should be the more likely scenario) your initial sell stop level isn’t reached. The trick is that once you have started to make a profit on the trade, you need to move your sell stop up to a higher price – thereby locking in your profit. Ideally you need a precise method of knowing how much and when to move the sell stop up. Two day graduates, you have already learnt how to use a trail sell stop on the most recent share price bottom.
Using a sell stop and moving it up as the shares price goes higher (called a trailing sell stop) takes care of common investing mistake number three – Cutting your profits short OR Selling a share too soon. Why do we do it – take our profits too soon? For the same reason that most stock market mistakes are made – human emotions – mainly fear or greed. A typical reaction once we have made a small profit is to want to sell the share out of a fear that we may lose it. Using a trailing sell stop makes sure that you hold on to the share for its full move up as your share will only be sold if it makes a significant drop down to you current sell stop.
Darren Winters
Lets tackle those run away loses first. Come on, own up, how many of you have bought shares that have started to drop and you have just held on to them as they dropped further and further. When I first started out, I initially fell into the same trap –
you know what I’m talking about - you have just brought the shares and maybe after an initial increase they start to drop. What do you say to yourself?: “Well the share has only dropped a bit, it’s a great share and I bought it at a good price, it’s got to be about to go up” - 2 months later and a further 20% drop in the share price: “If its gone down this far, it can’t go much further, it really is a great price now, it’s got to be ready to turn” - 6 months later and another 40% drop in share price: “Well it’s too cheap to be worth selling now, and my stock broker told me that it is for the long term any way – maybe I should buy some more?” 10 months later and the company is declared bankrupt ... maybe!
How to Avoid: Letting your loses run, and cutting your profits short
There is no reason that you should ever find yourself in this situation, if you just follow this one basic rule: As soon as you buy a share always place a sell stop order. For those of you who are new investors, what does this mean? A sell stop is simply an automatic order that you give to your stock broker (a real person by telephone or through the internet online) to sell your shares if they ever drop below a certain level that you set. Now you might be thinking to yourself “Well surely that means that if my shares are sold only when they drop below a certain level that guarantees that I lose money?” Well YES and NO. If your shares price drops far enough below the price you bought it at, you will lose money, but only a limited amount. However if your share goes up in price (after doing your fundamental checks / basic chart reading mentioned above, this should be the more likely scenario) your initial sell stop level isn’t reached. The trick is that once you have started to make a profit on the trade, you need to move your sell stop up to a higher price – thereby locking in your profit. Ideally you need a precise method of knowing how much and when to move the sell stop up. Two day graduates, you have already learnt how to use a trail sell stop on the most recent share price bottom.
Using a sell stop and moving it up as the shares price goes higher (called a trailing sell stop) takes care of common investing mistake number three – Cutting your profits short OR Selling a share too soon. Why do we do it – take our profits too soon? For the same reason that most stock market mistakes are made – human emotions – mainly fear or greed. A typical reaction once we have made a small profit is to want to sell the share out of a fear that we may lose it. Using a trailing sell stop makes sure that you hold on to the share for its full move up as your share will only be sold if it makes a significant drop down to you current sell stop.
Darren Winters
posted by Darren Winters at 10:52 AM
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