My friend Craig works at a brokerage firm. When we spoke over the weekend, he was tired from all the calls he received on Friday by clients wanting to close out their brokerage accounts. And after the gargantuan drops in the market both Monday and again Wednesday, I’m sure the cancelation calls kept coming. As the saying goes, “the bull (buying) goes up the stairs, the bear (selling) goes out the window.” The dominant motivation for selling (emotional fear and panic) is much more intense than the dominant motivation for buying (emotional happiness and jubilation). They are among the casualties. Sad but true, if they knew a few basic concepts, they would still be alive.
Risk management keeps you from becoming one of the casualties. It keeps you ALIVE in both the short and long runs. It is the key to both being profitable in the market and sleeping peacefully at night no matter what the market is doing. “Risk management” means different things to different people. Here is the reality: if you invest in the stock market, you will have at least one losing trade. Despite what your significant other says, no one is right all of the time. This is why it’s called “Risk Management,” not “Risk Elimination.”
Most sports fans have heard the following: “Offense wins games; defense wins championships.” Risk management is your defense. If you don’t believe championships are more important, just ask anyone on the losing team of the Super Bowl. Does the New England Patriots / New York Giants game ring a bell?
Know how much you are willing to risk before you enter the investment, not afterwards. Timing is critical. If you wait until you are in the investment to make this decision, your emotions will dictate your actions. And that is a huge mistake. If you want to make money in the market, make decisions objectively based on a proven systematic approach, not based on emotion.
Looking at my own experience over the past thirteen years, I have made hundreds of trades. Out of ten trades, seven of them will be profitable, two will lose money, and one will break even. Like I said, no one is right all of the time. The key is knowing when to let the losing trades go. I am not willing to lose (risk) more than 20% before I exit a losing trade. I make this decision BEFORE I enter the investment. This is part of my systematic approach, and what enables me to minimize my emotions. I make a decision beforehand, and I stick to it. That is why so many people wind up losing money in the long run because they stay in a particular investment for too long. It is better to exit a trade and preserve the remainder of your investment capital by letting it sit in cash, than to ride a train into the mountain. For me, a 20% drop from my initial cost basis indicates “mountain.” So, I get off. It’s that simple. In the seven trades that are profitable, I let my profits run, and I am not willing to lose more than 20% before I exit a losing trade. This is how I have been profitable in the stock market in the long run. I am not special. Others can do this too.
That being said, there are ways to make money not only when the stock goes up, but also when it goes down, or stays in a horizontal channel. I have done all three. And I am not talking about shorting stock either. I will save that topic for next time…
I’m ALIVE! I hope you are too! Stay ALIVE on your journey!
Aneshia