When ever you deal with the stock market you should be treating your trading as a business, because that is exactly what it is. Here we will examine one of the most crucial things to keep in mind while trading; you must preserve your capital.
Nothing hurts worse than executing a trade that ends in a loss. Even more saddening is a trade that completely wipes out your portfolio. Let’s get this out of the way. Everyone makes losing trades. From the gurus on Wall Street to your next door neighbor. The people who are successful are not the ones who never take a loss, but they are the individuals who are able to manage and limit the losses they do have.
So how do you go about managing your losses? You must have a stop loss in place. Many will argue that the stop loss should be automatically triggered while others say you should have the stop loss jotted down mentally and execute it when necessary. How ever you go about it, trading without a stop loss is one step away from disaster.
How Much Can You Lose?
Why a stop loss? When most people open a position they instantly start to think of how much money they will make if the trade goes their way. Few beginners ever consider how much money they can lose if the trade goes against them. What they fail to realize is that most trades pose the risk of losing ALL of the capital invested. Many options in particular expire worthless. This is one of the many reasons why covered call writing can be a consistently profitable options trading strategy.
A popular way of measuring where to place a stop loss is in comparison to the maximum return your position could achieve. The least you should shoot for is a 1 to 1 ratio. Basically the most that you can make with that particular position should be the most you are willing to lose. If your trade aims to make $100 then you should not be willing to part with more than $100 if the position starts to loose money.
So when you continue with your investing journey, always be mindful to keep watch over your capital. It’s not the end of the world if you have a losing trade, just make sure you don’t lose your entire portfolio.