October 28, 2015

How does Charles Darwin’s piece of advice translate to the world of investing: It means that you better know when to sell your position in a stock when things change for the worst. It’s easy to fall in love and buy a stock for your portfolio, but it doesn’t matter how much conviction you have for that company, if the stock price drops 7-8% from where you bought it then according to IBD Chairman William O’Neil, it is not likely to recover. It’s a rule many beginning investors have trouble following, because they don’t understand the mathematics and they just can’t bring themselves to lock in a loss. They hope the stock will come back, but often that’s not how it works.

Treat each stock loss as a bite to your total portfolio’s health. The smaller the bites, the better off you’ll be. Generally speaking, if the loss on a stock does not take more than 1% of your portfolio’s total equity, you’re cutting losses properly. Plus if you are focused on a falling knife, you are going to miss the shooting stars that can bring your portfolio back to a profitable place. So remember: if you decide to take on the stock market to try and obtain an better return than your bank CD can offer, you better understand how to use a stop-loss order or you will end up underwater before you can blink.