One thing that you will see me talk about fairly repetitiously if you read this blog over time is the necessity to avoid losses. While so many people focus on making gains, I firmly believe that avoiding losses, especially big ones, is an equally important element of long-term financial abundance. One way to do this is to use stops (correctly, a stop-loss order). A stop is a sell order that will automatically sell a losing security or investment at a predetermined price thus preventing your loss from growing. In its investor education, Investors Business Daily is adamant that investors should set stops no greater than -7% to -8%.
Another way to limit downsides is to set alerts using Marketclub’s trade triangles. These give us buy (green) or sell (red) signals. We use the long-term monthly trade triangles to direct our Simple and Conservative portfolios. Members may set an automatic e-mail alert to notify them of a red or negative trade triangle. This would be a signal to close a position if we were using the trade triangles instead of a stop-loss order. However, you do have to have the discipline to follow through and sell the offending investment yourself.
If we’re honest I think we’ve all held onto a losing investment in the hope that it will “come back”. This is an example of why that is an altogether bad strategy:
This is a chart of Constellation Energy Partners LLC. I came across it while doing research on another project If you had been holding CEP in the hope that it would come back from its high of ~$50 back in 2007, you’d be a bit frustrated by now. A stop-loss, or, as you can see from the chart, the red monthly trade triangles would have saved us from ourselves quite effectively.
We’ll have more on stops in future posts, their uses, abuses and limitations, but the take-home is you HAVE to limit your losses.
