“So… aren’t you worried about this morning’s selloff in stocks?” my wife asked.
“I think this morning was the bottom,” I told her… “It felt like panic selling. I think prices will go up from here – at least, they’ve gone up every time we’ve seen a similar situation in the past.”
“Didn’t you tell me that you’re probably going to stop out of a lot of positions at the end of today?” she said.
“Yes.”[ad#Google Adsense 336×280-IA]”And you think the market’s going to go up, right?”
“Let me get this straight… You think the market is going up, and yet you’re selling…”
“Yes, that’s right.”
“Hmm… How are you OK with that?” she asked.
I understand what she’s saying… How can I be selling if I think the market is going up?
There are two ideas at work here, and one is much more important than the other.
The first idea here is risk control. The second idea is simply my (somewhat) educated guess.
Controlling your risk – setting your point of “maximum pain” and sticking to it – is critical not only to making big profits, but also to simply “living to fight another day” in the markets.
This idea is far more important than my guess about where the markets are going.
Controlling your risk is also extremely difficult to put into action. The thing is, you have to do it. You can’t risk seeing your retirement go down with the ship.
It’s irrelevant whether you’re locking in a big gain or taking a loss… The key thing is GETTING OUT – controlling your risk – when the time comes.
I remember stopping out of most of my stocks in April 2000. The Nasdaq Index had peaked at more than 5,000 in March… And I stopped out of most of my stocks just a month later. It sure is a good thing I did… The Nasdaq Index had lost nearly 80% of its value by the time it hit bottom a little more than two years later.
I couldn’t have known at the time that the market was just starting an 80% fall… What I did know was that I was protecting my wealth. I was controlling my risk. I was living to fight another day. Boy, am I glad I followed my stops then!
Fast forward to today… Yes, I think the market could go higher from here… and yes, I’m following my trailing stops and selling some positions.
At first that might sound contradictory, or even a bit strange… But it’s crystal clear in my head:
Controlling my risk trumps whatever my opinion is about the markets. Plain and simple. And it always will.
Source: Daily Wealth