Keeping Losses Small Is Critical To Portfolio Progress – Investor's Business Daily

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Most people aren’t a fan of losing, especially when it comes to money. But for a swing trader, losses are an inevitable part of the business. The trick is to keep the losses small so they don’t do terrible damage to your portfolio. Being able to recover quickly is critical to your psychology as well as your profits.

This is easier said than done for many investors. Some feel taking any loss is equivalent to admitting defeat. As long as the loss is only on paper, hope remains that they eventually will be proven right. But trying to save a bruised ego by ignoring a paper loss could set you up for a lot more pain as losses mount.

There is also the fear that once a loss is taken, the stock will immediately bounce back without you. That fear needs to be balanced with the possibility that the small loss can turn into a larger loss. Nearly as bad is that you could be sitting on dead money for a long period of time waiting for the stock to recover. While waiting, your capital is at risk with the reward potential questionable.

What happens if the loss gets larger than expected? Usually it’s best to part ways. Your original thesis has been proven wrong and fighting it just compounds the problem. Thinking that the worst is over is also naive. The phrase “it can’t go any lower” is proven wrong almost every day by the stock market. Taking the loss when it’s small sidesteps much of the internal dialogue seeped in emotion.

That proved to be the case with Shopify (SHOP), a recent trade on IBD’s SwingTrader. The stock was added as it broke out June 2 in the heaviest volume in eight days (1). The Nasdaq composite was also moving to new highs from a four-day tight area. Volume quickly vanished the next couple days as the stock labored to surpass the 100 price level.

On June 9, the stock did cross 100 but then quickly reversed (2) as the tech sector fell and brought the Nasdaq composite down with it. With the shift in the market, Shopify was cut loose early in the day with less than a 1% loss from its entry on SwingTrader. The stock did close the day decisively below the 5-day moving average, a sell signal outlined in the trade setup. But the early sell alert prevented that tiny loss from ballooning into a 6% hit. Things only got worse as Shopify tumbled an additional 9% the following week.

How does this translate to managing your portfolio? Well, on the same day Shopify was removed from SwingTrader, profits were also booked for Align Technology (ALGN) with gains over 5%. Letting the losses magnify in Shopify could have easily wiped out all the profits in Align.

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