Hint: It's all about perception.

by Makoy Velasco, Certified Securities Representative

Let’s talk about the very thing that traders dread the most: LOSSES.

One of the reasons why traders lose a lot of money is having the wrong mindset and perception about losses. Such wrong perception and mindset leads to wrong decisions and such wrong decisions leads to enormous and insurmountable losses.

A right and healthy mindset about losses is a KEY in achieving success in stock market trading and making lots of money.

The secret in getting rid of fear of losses is to accept the fact that losses is indeed part of trading. No successful trader made it to the top without losses. To say that trading without losses is possible is just like saying that life without failures (even petty ones) is possible. It’s obviously NOT.

Losses are unavoidable but it can be minimized. Profitable traders are great money managers. They are great in minimizing their losses. NEVER ever shift from being a short term trader to an investor if you got stuck in a certain stock. Instead, sell it with minimal losses and live to fight for another day.

Cutting losses is a very important trading skill to develop. Why wait to get your entire leg get burned when you feel the fire in your foot? Here are three reasons why cutting losses is extremely important in trading.

1. Losses magnify. You lose 10%, you need 11% gain to break even. You lose 25%, you need to earn 33% to get back your capital. You lose 50%, you need to double the remaining money you have to break even. Below is a table of the gain required (to break even) vs the amount of losses.

Philippine Stock Market Investing

Imagine if you lost more than 50%.

2. Opportunity Loss. Get rid of that “it’s ok, it will go back up anyway” mentality. Though it’s true that stock prices go up and down, the big question is WHEN? By holding on to a losing stock, you miss big opportunities.

Philippine Stock Market Investing

Take PX for example. I know some people who bought PX above P10 and are still holding on to the shares. PX’s share price started to drop mid-2011 and isn’t showing any signs of recovery yet. If you held on to PX when it dropped or worse, was averaging it down, how many opportunities do you think you have lost? URC rallied from around P30 to as high as P235 in that span. DD had its IPO at P2 and in barely two years, already hit more than P49.

3. Emotionally Damaging. Sitting on losses isn’t comfortable. It can ruin your day and even relationships (extreme cases). You may argue “what if the stock price goes back up after I sell?”. The objective is to save your portfolio from becoming a casualty because “what if the price will keep on dropping if you hold on?”. Don’t worry about the price getting back up, you can buy it back anyway or better yet, find a different stock with a better set up.

Cutting losses is like running and getting out of the emergency exit when the building is on fire. You may have some burns but the important thing is you’re alive. Always think, it’s better to get hit by a number of jabs than one knockout punch.