Whether you are a novice or an experienced investor, everyone makes mistakes from time to time. It is easy to get discouraged if your losses pile up faster than your wins. But, tackling your losses holds the key to success in the stock market.
How so, you might ask?
The answer lies in this dictum: Lose a little when you lose, and gain a lot, when you win.
After studying stocks for years, MarketSmith founder William O’Neil found that the best institutional-quality stocks rarely fall more than an 8% from a proper buy point in a sound chart pattern. Thus, an 8% stop-loss and selling a stock when it breaks key support levels can save you from huge capital erosion.
“If a speculator is correct half of the time, he is hitting a good average,” famous Wall Street investor, Bernard Baruch had said. “Even being right three or four times out of 10 should yield a person a fortune if he has the sense to cut his losses quickly on the ventures where he has been wrong.”
If a stock is falling below its key support levels such as a 50-day moving average or a 200-day moving average (more applicable for low-cost holdings), it means it is not finding institutional support. A fall on high volume below these support levels warrants extra caution.
Another important rule is to track general market direction. The distribution day count on the index also plays an important role. If a major index (Nifty50 in our case) falls 0.2% or more on higher than previous sessions, then it qualifies to be a distribution day. Accumulation of distribution days signals the weakness in the market. As the distribution increases, trim down the exposure toward the equity market.
When you follow such sell rules, you do not let the losses become too big, and cut them short quickly. Stocks might rebound, but you are saving yourself from the probability of a higher sell-off.
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