All of a sudden, your favorite small cap stock is falling out of the sky.
What do you do? Do you sell? Do you hold?
Or, do you freeze, becoming nothing more than a nervous, emotional trader that sells because everybody else is? Unfortunately, most of us freeze, too scared to think straight.
We get caught up in the mad rush of herd mentality.
Instead of calmly looking into why a stock may be falling (sometimes for no reason), we slowly lose our minds and sell. But that’s the wrong way to trade.
One of those plans must involve what’s known as the trailing stop loss – the very exit strategy that removes all emotion from the trade. If your stop is hit, you’re out automatically. There’s no second-guessing. If your stock pushes higher, the trailing stop resets higher, too, never triggering until it plummets.
For example, let’s say that in the middle of January 2019, I risked $10,000 on a small cap stock that trades at $10. When the stock reaches $16, I’m sitting on good money. All of a sudden, the stock starts to fall to $11 because run is ending, and as others panic on the pullback.
What to do? Panic and sell like a fool?
Or protect the gains I have without emotion?
I’d choose the latter with a -10% trailing stop, for example, which means if the stock now pulls back 10% from current prices, I’m automatically stopped out, no questions asked.
Now, if the stock continues to move higher, my stop is never triggered. It allows unlimited capital appreciation. As long as a stock keeps going up, the trailing stop will never get triggered.
Such a stop keeps us from selling our stocks at the wrong time while in a solid uptrend, while preventing losses from wiping out your portfolio. Basically, it forces a stock to be sold. No emotions. No fretting. It’s all automatic.
Meanwhile, your worst-case scenario is cut down to losing.
This strategy keeps you in winners and gets you out of losers. And over time will go a long way to making you a much wealthier investor.