The Trading Costs of Loss
Capital preservation is the number one key to trading another day. Yes, as a trader your goal overall is to make money in the market. However, you can not make money without capital.
Simply put, be in the market when the probabilities favor higher prices and exit either when the market is too pricey or the market technicals begin to deteriorate.
All of this is easier said than done. Especially when you see the market provide false signals including bearish and bullish traps. The minute your signal goes off that there is a market breakout, you enter with a sizable position only to see your gains disappear the next day. This has been the case for much of early 2014. The market has been extremely choppy for much of this year. As of April 4th, 2014, the S&P index is only up 0.91% year-to-date after peaking around 1894 last Wednesday and Thursday. Compare this to prior year same period of 4.52%.
Without a doubt it has been a difficult market to trade in thus far. In times when markets are choppy and it seems as if bear traps are beginning to form, it is important to take a serious look at capital preservation. If we do not, we risk the chance that our trading capital takes a serious blow. While the blow may be temporary in the long run as we've seen the U.S. economy recover time and time again, in the short-term you could be waiting months or years before you get back what you lost. While losses in trading are inevitable, you job as a trader is to limit losses
The cost of losing is high. Suppose you have $50 invested in Google and the stock drops 50% over a couple months. Now your stock is worth $25 and in order to get back to that $50 cost basis, you will have to have the stock double in value.
Is it better to overpay for a high returning stock now than to buy a stock that has moderate returns now at a fair price? The answer is the latter. If you buy an overpriced stock now and the stock drops 50%, at 10% annualized returns, it will take you about sixteen years to match the value of that of a stock that grows at 5%. The lesson here is to preserve your capital because losing can be very costly
Labels: Finances, Pro Stock Trading Tips