Cut Loss & Affordability (Mentality)

Before you proceed to study Technical Analysis and become a trader, please be reminded to get your mentalities right. To me, the first thing that you need do before you even think of becoming a trader is to calculate how much money you can afford to loose. Pathetic don’t you think? People go into stocks to earn money, but this stupid guy tells me to think about how much I can loose first?

Wait… Let me explain…. First of all, technical analysis (TA) is not a miracle method that can give you 100% accuracy. No matter how much you have read, how many charts you have studied, how great indicators are, technical analysis is just not correct all the time…. Especially when you are just starting to try this technique. You may hear your friends or some super guru on TA tell you about this miracle setting or indicator that will help you pick out winners… But once you try things out… You may find that it is just not that simple… So many things can go wrong… Misinterpretations, misleading and contradicting indicators, unexpected change in crowd behaviour… etc… So, how can you make sure that you are correct 100%? Whether you like it or not, TA is actually using the chart to predict the behavior of the crowd based on history… But whipsaws do happen… a simple bad news may cause mass panic which leads to panic selling…

The key to be a successful trader is to survive all this mistakes long enough in order to find the correct way to get it right… Which is why the rule of thumb for trading is to “keep loss small and let profit run”.

But how small is small? When to cut loss? This will be discussed further in future postings… But to make it simple, when you enter a trade, there has to be a buy signal that you use. It doesn’t matter if it is trend, MACD, Moving average, breakout… etc. But you must know why you entered in the first place… So, you must be prepared to cut loss once you find that the reason is no longer there… For example, if you entered because of uptrend, you must be prepared to cut loss once you realized you made a mistake when the price violates the trend.

However, another important point to remember about cutting loss is affordability. As we know, the financial status of everyone is different and this can affect the cut loss level to a certain extent. Some people like to say that your cut loss level should not be more than 2% of your capital. I would like to say that your cut loss level should be kept to the amount that you can afford if you were to make 5 consecutive losses, or 2 % of your capital, whichever lower.

With this affordability in mind, you will use them when choosing counters. I think we should not enter a trade when the cut loss level is above your affordability. It is safer to pass those trades. So, please remember this two points, Cut Loss & Affordability when you choose to trade.

Happy trading…