How To Protect Your Downside Risk – And Increase Your Upside Profits
One of the worst things you can do in any situation is panic. Let your emotions get the better of you. Often times when you take a minute and step away from the situation you can see it from a different perspective.
The thing about knee-jerk reactions to major events is your instincts are usually incorrect.
That’s why it’s important to have some protocols in place to help make those tough decisions for you.
Look what happened when our good friends the Brits voted to leave the EU…
The market hit the panic button – mainly because Wall Street thought that there’s no way Britain would leave the EU.
Well… they were wrong and you, most likely, suffered the consequences.
Most people woke up that Friday morning and did exactly what they should not have done – panic – and sell.
In retrospect it’s always easier to say don’t panic – just hold on. But people make decisions based off of emotion…
And letting emotions dictate your investing strategy is probably what hurt you the most.
Instead – having protocols in place could probably could have made the pain hurt less and given you some outside prospective.
Here’s what I mean…
Friday happened and there’s a good chance most of your holdings took a hit. But were they down…
Because of some fundamental deficiency with the company?
Because the stock hit some technical trigger?
No – they were down based on emotional trading and people feeding into the panic of the event by watching the news.
So the question for you became: do I stop the bleeding and sell now… because I don’t know how far it will drop?
The answer should have been easy – if you had your protocol in place – it could have answered that question for you.
The best protocols are your upside price targets and your downside stop losses. If you set those for each investment – then you don’t’ have to make those irrational decisions like many did on Friday. Your portfolio would work on its own.
Typically people put a stop loss anywhere from 15-20% on the downside. I’d never go higher than 20%.
This allows for a stock to react to news and other catalysts that spike volatility and cause bigger than normal price swings. If the position is 20% down – forget about it and move on. Don’t let emotions tell you… “Well maybe I can see what happens tomorrow before I decide to sell.”
Set a stop loss and stick to it. It’s a lot less stressful than trying to make the decision yourself.
Upside price targets work the same. I suggest using 2 price targets though… this helps give you more upside – and also protects your downside.
Set the first price target somewhere between 10-20%. If the investment hits this target – sell half of your position (preserve your gains).
Then take the other half of the position and set a more ambitious 2nd price target – that can be anywhere from 25-100% or more.
But it’s important to also readjust your stop loss to a point where the worst that can happen for the second part of your trade is you hit a stop loss and sell out for a profit.
The adjusted stop loss on the second half should be anywhere from 5-10% above your entry price.
Looking at the Brexit events and how they affected your portfolio…
Friday and Monday were free falling. Lots of selling and losses. But come Tuesday, Wednesday and Thursday and the market started buying back.
Take a look at your portfolio and your actions…
Did you use stop losses and price targets that helped mitigate your risk and preserve your upside potential?
Or did you make an irrational decision based off pure emotions?
With price targets and stop losses in place – you know your maximum profit and loss. If you trade freely – there’s no telling where your portfolio might be sitting. You could have left a lot of profits off the table by reacting and selling too quickly.
Because at the end of the day – If a stock drops to its stop loss – you sell it. If it hits its price target – you sell it.
Use this protocol to protect your downside risk and increase your upside profit potential. You’ll never have to wake up and take on the stress of having to make those difficult, emotional decisions to events like Brexit.
Because they will happen again. And it’s important to protect your wealth with a simple yet effective protocol like setting up a stop loss and price target for every trade.
Regards,
Ethan Warrick
Editor
Wealth Authority
