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Editor's note: Today's entry in our weeklong series of the differences between professional speculators and amateur investors shows the power of limiting your losses and maximizing your gains... and how it can make you rich.
Thursday, May 28, 2015
When you invest in the market, you're going to have losing trades. It's inevitable. It's just part of the business.
That's why having an exit strategy is so important. As I showed you yesterday, it will protect you from big losses and maximize your gains by telling you when to sell a stock.
Today, I'm going to show you just how powerful the idea of letting your winners ride and cutting your losers short is. And why it matters more than your winning percentage...
Amateur investors and traders place way too much emphasis on their winning percentages. Professionals like high winning percentages, but they're not their primary concern.
You see, professional speculators know you don't need to be right 100% of the time. Some of the greatest traders of all time were only right 50% or 60% of the time. You can get filthy rich in the market by being right just 50% of the time if you follow an exit strategy.
The key to making huge returns in the market is to win a lot when you're right and lose a little when you're wrong.
To get an idea of how important this idea is, consider this situation.
On January 1, you buy 10 stocks. You put 10% of your account into each stock. You use no exit strategies. You just buy and hold for a year.
That year goes by... and here are the changes in your stocks.
You bought 10 different stocks. Five went up. Five went down.
The total percentage gain of the winners is 400%. The total percentage loss of the losers is -400%.
If you purchased those 10 stocks and held them through thick and thin, you'd end up flat. You wouldn't lose money... but you wouldn't make money.
You would hit some solid winners... but a handful of big losers would kill your overall performance.
Now, let's say you bought the same handful of stocks... but used a simple exit strategy. You cut every loser short. If a stock declined 35% below your purchase price, you would sell it, no questions asked. As for your winners, you'd simply ride them all year.
Here are the results.
Again... you bought 10 different stocks. Five went up. Five went down. But you aggressively closed your positions if they declined 35% below your entry price.
Because of this, your winners totaled 400% and your losers totaled -175%. This works out to a total percentage gain of 225%, or an excellent average win of 22.5% across the 10 positions.
And you made this excellent return while being right just 50% of the time.
This is the power of winning a lot when you are right and losing just a little when you are wrong.
Editor's note: Paul recently found one of the best speculations he has come across in 25 years of investing... and it could lead to massive gains. This company has developed what could be the biggest medical breakthrough of the decade. He believes this stock could double over the next year... and turn every $5,000 invested into $135,000 over the next decade and beyond.
If you want to make big money in the markets, Steve Sjuggerud says you have to do what he does: let your winners ride as long as possible. "It's hard to do... but if you want to maximize your profits, it is what you must do," he writes. Get all the details here.
Stansberry Research Editor in Chief Brian Hunt says cutting your losses is "the key to turning your trading into a lifetime builder of wealth." But for most traders, the execution of this idea is difficult. If you're one of these traders, Brian says there's a technique you can use. Learn what it is right here.