Cut Your Losses Short

Warren Buffett said there were only two rules to follow with your investments:

• Rule #1: Don’t lose money.
• Rule #2: Don’t forget Rule #1.

As a normal investor, no one wants to sell for a loss or book the loss. Most of the time we are not ready to admit that we made a mistake. The problem is that market doesn't care who we are, what we think or how much we believe in a stock before investment. Market is really cruel in this respect, so keep your ego aside and take a small loss before it turns bigger.

But if a stock drops 15%, 20% or 25% from our initial purchase price, isn’t it simply a better buy at lower prices with same fundamentals? Why would someone actually sell just because the stock temporarily falls? If it falls we should ask ourselves that why it fell? It may fall due to reasons below

• Market correction
• Fundamental changed for the company or industry.

If the stock fall without market correction then it is the time to think about your holding. We have to limit our loss. The limit can differ person to person and sock to sock. Once you decide to limit say 8% or 10% then go for it. If you don’t cut your loss then it will impact your portfolio return.

Suppose you have exited form a stock which has fell 8% from your purchased price and reinvest the sum in some other stock i.e. 92% amount of your initial investment. Then this new investment must earn 8.69% for break even. Similarly if you book your loss at 15% then the next investment should earn 17.65% which is more than double…

Cutting losses is like having insurance so please cut your loss short and invest again.