The Reason Why Cut Loss is Really Important in Stock Trading

In Business Skills, Investment Skills
Why to Do Cut Loss?

There would be times when you need to do cut loss in forex trading if the stock price probability seems hard to get up back. Find out more what cut loss is, why every trader needs to stipulate cut loss, when and how to use cut loss strategy.

Particularly, stock traders sure that when they get sizable losses means that they purchased the stock at the wrong time. Such issue is a matter of bad luck for them in stock trading, just like gambling. But most of them don’t assume that their big losses did because of doing not to cut loss.

Cut Loss Strategy in Stock Trading

Stock trading is a type of investment that has potential losses. In an online stock trading, it is a common strategy to limit loss and avoid big loss by setting a cut loss limit that is appropriate with the risk profile of loss that can be borne.

An investor in stock trading, whether a beginner or veteran must know about cut loss strategy. You can set a cut loss by selling the stock at a lower price lower than the time when you buy it. It means you are not making a profit in doing cut loss. But deciding to cut loss means you give up at a small loss rather than a big loss if you continue keeping the stock in your portfolio.

In a simpler definition, a cut loss is an effort to prevent big loss in trading. When you decide to cut loss, it doesn’t mean that you are making a loss, but to prevent big more losses when the market trend of a certain stock you traded keep falling down.

Suppose you set a cut loss limit for a stock trading to 5 to 10 percent of the loss. So if the loss has reached that range, you can immediately sell it, so you will not get more loss greater than that range.

Conversely, when you sell a stock when its price higher than the purchase price, it’s called as a profit taking or realizing a profit. But not to cut the potential profit you can still achieve.

That means you may only sell your shares when you estimate that the potential price movement is likely to fall in the near future.

Certainly, many investors hate cut loss and therefore some investors decide not to cut loss when the price of the stock they bought actually goes down.

In such case, the mindset those investors who hate cut loss is that if they sell the stock in a loss position, that means realizing the loss incurred, rather than cut loss or preventing greater loss.

Why Should Traders Set Cut Loss?

Doing a cut loss setting cut loss is necessary to maintain capital. Without setting cut loss, investors will not have the safeguard to keep their capital when a financial crisis happens. Allways setting cut loss limit is also used to prevent something unexpected like the company performance which the shares you hold are held is going down. Therefore, the cut loss is also called as a protective stop.

When is the Right Time to Cut Loss?

The right time for doing Cut Loss may vary depending on your position in the stock transaction. Because whether you are an active stock trader or investing for a long-term, each of both has a different time frame in determining when to do cut loss.

Cut Loss for an Active Trader

If you are an active trader, when the stock you hold the price is going lower, then you should immediately sell it. That is the cut loss in active trading. But when the stock is likely going up, you can keep it.

The key here is to try to find out what direction the stock price movement next. Whether it goes lower or higher, goes up, or soon would up again in a short-term, you have to be capable of reading the market trend for a stock price movement on the chart.

The short-term time duration in stock trading is less than a year. Sometimes a short-term trading could be less than a few months depending on your trading period. Given that if you hold a stock in a loss position but you do cut loss immediately, then, when after a year the stock price finally returns back to the initial price, you do not lose money, but you lose time.

One year is a relatively a valuable time in trading activities. There are many stocks on New York Stock Exchange or NASDAQ that can generate more than 2o percent profits in one year period of time.

Cut Loss for an Investor

Traders are different with investors. If you are an investor, you can do cut loss when there is a fundamental change. An investor who buys stock on the basis of his fundamental needs to take a closer look at the fundamental performance of a company which the stock that the investor would like to buy. When the fundamental performance of the company deteriorates and does not allow the price to go up again, that’s the right time for investors to do cut loss.

Some other reasons why investors sell their stocks are if there’s bad news about the company concerned. Or perhaps a decline in NYSE Composite Index, where you should sell all of your stock holdings, especially the stocks those the price movements are easily influenced by the index.

Using the Cut Loss Strategy

That description above implies that the meaning of cut loss is to sell a stock which its price is likely still falling further lower. There’s no trade capable of making sure the consistency of potential profits for the following days, weeks, or years. It’s why become a full-time stock trader is not recommended. But how investors know that the stocks they hold can still go lower again, read the following.

There are 2 ways they can use as a benchmark in determining the cut loss point of a stock, as an example, from the stock buying price and based on its support point.

Cut Loss based on Buying Price

In this case, you set a cut loss limit if the loss has been 5 to 10 percent of your capital. So, when the loss has reached that range, you can immediately sell it to prevent further losses.

This method isn’t too flexible as it doesn’t consider the prospect of stock price movements in the future.

Cut Loss Based on Support

Cut loss can also be done based on its support point. If you read the daily stock recommendations which commonly sent by securities, there are at least three important prices for each recommended stock, the purchase price, the target price, and the cut loss price. Take a look at the following example:

XYZ Stock Price:

  • Current position = $15.00
  • Buy if break = $16.00
  • Cut loss if = $14.00
  • Target = $18.00

In that recommendation, the cut loss point is usually the stock’s support point, which if the break, then the movement of the stock can continue its decline. To understand more about the support point, learn more about support and system in a stock trading chart.

Is Cut Loss a Failure?

When the first time you heard about cut loss, a question may come up in your head; does an investor fail to do a cut loss?

The answer is no. Cut loss in investing or stock trading is a form of admitting losing and with the cut loss then, the fund is not locked so as it can be used for other transactions. It doesn’t a real problem if you lose as you alert in doing cut loss for another profit opportunity.

Stock trading isn’t  totally gambling, to make profits in stock trading need basic skills of forex trading. Having stock trading skills may help you make profits and prevent losses.

Do a Cut Loss

Do cut loss if, after your re-analyze, it turns out that the potential price movement will tend to decrease. If it turns out your cut loss decision is right, means you prevent yourself from greater losses.

But if it turns out your decision in doing the wrong cut loss, it means the stock price movement will move towards your initial expectation.

Have you ever invested in stock, forex, or commodities trading? How often you do cut loss on your transactions? So, what do you think about the cut loss in stock trading? If you would like to share your trading experiences, please comment below.

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