Part of a good defense in investing is knowing the impact of losses and why we want to keep them small. Losses do not get better as they float downstream. Look at what an investor has to make back each time they take an excessive loss and this is just to get back even.

 

25% loss = 33% gain

33% loss = 50% gain

50% loss = 100% gain

75% loss = 300% gain

 

These are the numbers. Having them top of mind might help when you get tempted to make a high risk trade with your hard earned money. It's not very hard to lose 50% on a stock these days, even in "defensive" stocks. When was the last time you made a 100% on a trade in this market?

 

All stocks are risky; every trade entails risk. Managing that risk is critical for long term success. Besides proper stock selection and timing, handling losses is the most important part of risk management. In the MarketSmith shop, if we are down 7% on a position, we close it. Period. We never let the story or the fundamentals override a loss. Never, no matter how much we like the company.

 

Numerous emotional traps are avoided by staying disciplined with these rules. To further put the odds in our favor, we always consult a stock chart before making a trade. Where a stock is on the chart is as important as a good story with solid fundamentals. In our shop, defense always comes first.

 

Best Returns,


W. Scott O'Neil

President, MarketSmith Incorporated

Follow on Twitter: http://twitter.com/#!/WScottONeil