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Cutting losses short is one of the best things you can do in the stock market. Most people believe that in order to be a professional trader you have to take big risks and never lose. This is a very farfetched tale because the people who tend to take too big of risks in the market wind up broke and no one is right 100% of the time.
One of the biggest keys to being successful is simply keeping your losses as small as possible. By doing this you increase your chances of being profitable. It can also give you these five benefits.
1. You Don’t Lose Everything Just On 1 Trade
If you are taking too big of risks then all you have to do is lose big once to take your account to zero. And it is just not possible to be right 100% of the time. So if you are always risking a big percentage of your account on any one trade then you are going to be in for a shook when you run into your first losing streak.
This is even more true true if you are trading options because you can really lose big here just on 1 trade.
2. Losing Streaks Do Happen
Everybody has good times and bad times. It is a fact of life, sometimes you win and sometimes you lose. The stock market is one of those places that you can lose everything during your down times. To counter this it is really important to keep your losses as small as possible.
This way you may be able to lose 3 or 4 times in a row and you still have money left over in your account for your next big win.
3. Less often You Have to Be Right
How often do you need to be right if you make $2 every time you are and lose $1 every time you are wrong? Over a third of the time. With a risk to reward ratio of 2/1 you can be wrong 60% of the time and still be profitable in the long term.
That sounds pretty good, and if you are really bad at picking stocks and are only right let’s say 30% of the time time or so then you can always increase your risk to reward to give you a profit.
4. Less Emotions
This is not thought about very much by new traders. But if you have ever attempted to learn stock trading you have probably realized that it is a very thing. These emotions can often times make you jump and do things that you normally would not do.
But if you are only risking a small percentage of your account on a trade, then you will not have as much emotional pressure on your shoulders this lets you make some better decisions.
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