How Does a Professional Stock Trader Manage Losses?

Nick Radge explains how professional stock traders manage losses. An amateur trader will try to avoid losses but this is not the correct way to trade.

In this video Nick mentions our new US Momentum strategy that has just been released.

I want to talk about a situation; when you come home from work, you’ve had a hard day, a hard week. You sit down and have a glass of wine. You decide later on you want to have a look at your share portfolio and you’re opening up your platform and sure enough one of your stocks has tanked. It’s down 30%, 40%. What do you do?

So, you probably have a couple of reactions when you check your portfolio and you see one of your stocks has tanked. It’s down 30% or 40% or 50%. Two reactions. The first one is probably a few expletives, a bit of furniture throwing. And then you think about it a little bit longer, and the next reaction you’re going to have, the next line of thought you’re probably going to have is, how can I avoid this?

How can I avoid being involved in a stock that’s going to drop 30, 40 or 50%?

And that’s the amateur mistake. You can’t avoid it. Don’t try and avoid it. That’s what amateurs do. It’s a fact of the stock market that sometimes these things are going to happen. More often than not, they happen when the stock in is a downtrend, but they can at times happen when the stock is in an uptrend.

How I Manage a Loss

Just recently I was involved with one, specifically Sirtex. And it was powering along, making nice gains, and one day it opened dramatically down, caught everybody off guard, caught all the big fund managers off guard. It happens. You can’t avoid it. If you want to avoid these things, you go and put your money in the bank and earn your 1%. That’s how you avoid risk. But the reason why the stock market gives you superior returns over the last hundred years is because there’s some of these risks involved. And amateurs go out of their way to try and avoid it and they drive themselves crazy. You can’t avoid it.

So here’s what you’ve got to do. You’ve got to ensure that, first of all, you’ve got a course of action if something happens. With Sirtex and myself, I exited the position because that’s what my trading plan told me to do. Nothing wrong with that. But the more important thing to understand is that you have to build your portfolio in a way that if one of these events does happen, it’s not going to blow your account or two, psychologically put so much pressure on you that you can’t trade anymore. In other words, it’s going to be a little bit uncomfortable, but it shouldn’t take you out of the game. And the way you do that is ensure that your portfolio has at least 20 positions. Probably no more. We recommend 20 positions.

Limit Your Losses

Now let’s take a look at this. Let’s assume our Sirtex stock, I think it dropped about 30%. I had a portfolio of 20 positions. That one individual stock, over my whole portfolio, represented one and a half percent of my equity. That’s not a terminal loss. Okay? I’m not saying it’s comfortable, but it’s not terminal and I can manage the loss. It’s not going to take me out of the game financially and it’s not going to take me out of the game psychologically. But the point is I’m not trying to avoid it.

I remain open to opportunity and don’t try and avoid the losses. I understand that that’s part of the risks we’re taking, but I manage them by having a diversified portfolio and understanding that when one of these situations happen… And they will happen. They can’t not happen. They have to happen occasionally. But it’s not going to take me out of the game.

And with the knowledge that it’s not going to take me out of the game financially and it’s not going to take me out of the game psychologically, then I can stay in the game and be there when the good times come along. That’s what you got to do – learn to manage your losses. So don’t try and avoid the situation. Put a plan into place, manage the position, and have a portfolio that ensures that should something nasty happen, it’s not going to take you out of the game.