Money management starts with protecting your capital, realizing profits and cutting losses. As I have stated previously, without cash, you can not invest. Cash is king and learning how to manage your cash is the most important aspect to investing in stocks. The game is won by lowering your risk by properly turning the numbers in your favor. Cutting losses is the best insurance to keeping your cash.
Emotions fuel the choices of several investors; leading the bunch is hope, fear and greed. So as to control these feelings, good money management skills have to be developed through a defined set of principles. How do you know if an investment is moving and working in the right direction? If it shows a gain, you’re right, if it shows a loss, something isn’t right and it could be time to protect your capital.
Most traders create the emotion of hope after a stock has declined in the initial purchase price. They hope it is going to rally and make promises to themselves that they’ll sell at breakeven. If and when the stock stinks, they break the promise and be greedy and decide to continue for a profit rather than selling. Normally, the stock will begin to decline and the investor will begin to accumulate losses. Investors are filled with pride and won’t acknowledge that their judgment is wrong, so instead, they opt to hold on and collect additional losses.
When a stock is bought and begins to decline, particularly on heavy volume, it’s time to admit you can be wrong and market before the reduction is too steep. If the stock rebounds after you sell, you could always reevaluate your position. Cutting losses is the best insurance an investor can have in their portfolio. By creating rules and removing emotion, investors can begin picking high quality stocks and purchasing them in their appropriate purchase points. This will decrease your risk and help keep you from using insurance. In my prior article, I explained how to create a watch list of top quality stocks using technical and fundamental analysis.