“I don´t wanna think about losses, I want to earn money!”
That’s what a friend of mine recently responded when I asked him about how much of his money he wanted to risk in his stocks.
Not long ago, this friend of mine had read an article about a company which was considered to be a good stock by an economic journalist. And having available some money in his account, my friend thought about buying some stock in this company and holding it in the long term. But before he did this, he came to me asking if this was a good investment. He thought, that with me being a trader, I could help him to make this decision. He expected to hear from me, whether this company and its products were successful. But that’s usually nothing I am really concerned about in everyday trading….
So I took a look at the company’s chart and yes, it looked quite well. It seemed to be in an upward trend and maybe I would buy some of these stocks myself in the next couple of days and test the trend. So far so good.
But then I asked my friend how much percent of his money he was ready to lose in this investment. This was not unusual for me because I define the maximum risk on every single trade in order to control the risk in my account.
But for him it was unusual. He looked at me and laughed:
“I don´t wanna think about losses, I want to earn money!”
Wow, this reaction reminded me that the majority of investors don’t think about this very important step before acquiring stocks.
You should always think about the losing side of a trade before you buy stocks. This is the only method that protects you from losing your whole account.
Always be aware how large the damage in that trade can get being on the wrong side of the move.
It’s an important rule to control the risk in your trading. And you should always do this if you want to invest in a company for years, like my friend wants to. Because if you don’t keep control of the maximum loss in your mind, you could easily be seduced to buy more stocks -while they are falling- to average down and thus, burn most of your money.
There are different rules about maximum loss. Some people say, never risk more than 10% of the invested sum in an title. Others say, never risk more than 1% or 2% of your account with one or with every trade. Whatever method you choose never forget to consider losses. And consider the volatility of the trade you are in.
You can easily define 1% as the maximum allowable loss in your account, always keep your stop and still lose your account, if you are not aware of the volatility of the trade you are in. That volatility could be higher than the 1% you have as a stop loss and therefore you get stopped out of every trade.