Knowing When to Cut Your Losses: A Very Important Lesson Learned
June 21st, 2009 at 6:00 pm Posted by The Dean
"Trade Penny Stocks Like a Tiger." -The Dean, CollegeStock.com
Honors Student Chris wrote me about his experience trading PASO back in 2006. He had discovered Stockwire’s latest play in advance of their announcement, using information publicly available on the web. He bought PASO at $.90 in anticipation of the advertising campaign, and based on Stockwire’s historical performance, the probability was good that the stock’s price would rise based on the upcoming advertising campaign alone.
For reasons unknown, PASO fell sharply after Stockwire’s campaign launch, but Chris continued to hold onto the stock, despite mounting evidence that it was only going to go lower. Chris finally sold his shares months later at $.05 per share, and lost 94% of his entire portfolio before finally cutting the cord.
Usually you buy a stock based upon speculative reasoning, and when these speculations never come to fruition, it’s all to easy to ‘fall in love’ with a particular stock that you feel is a winner. The reality you’d hoped for never happens, but you continue to feel that the stock is or still could be a big, big winner.
You need to cut your losses. Chris made the classic mistake of ‘falling in love’ with PASO, and though they may have been good reasons at the time, he failed to cut his losses when his speculative reasoning failed. It was almost like Chris was in quicksand, and no matter what he told himself, he only sunk more quickly.
You can’t go around losing 50%+ on every trade that doesn’t go your way and expect your porfolio to grow over the long term. Each person has their own level of risk tolerance, and every trader should identify his/her risk-tolerance and set stop-losses accordingly. A baseline of 10% is a good starting point, because it’s good to never lose more than 10% on any particular trade, and you just never know how exactly low a stock will go. (Zero, anybody?)
The most important penny stock trading lesson you can take away from Chris’ experience is to always cut your losses when the trade doesn’t go in your favor. When trading penny stocks, learn to cut your losses, and cut them quickly, because the risk is enormous.
