When I meet or correspond with Oxford Club readers who are fairly new to investing, a common theme arises: They beat themselves up over mistakes they've made. I explain to them that we've all paid "tuition" for learning how to invest, including me. But I'm not talking about investing classes. I mean taking losses because I didn't know what I was doing. Lord knows I've paid enough "tuition" for a doctorate from The School of Hard Knocks - without the benefit of a scholarship or grants. The good news is that my costly mistakes have taught me well. Today, I'm a better investor than I ever could have imagined when I first started 30 years ago - and I can help you avoid making some of the same mistakes I made. Lesson No. 1: Use a trailing stop. Not using trailing stops was one of my biggest "tuition" bills - and one that I paid over and over again. A trailing stop prevents a small loss from becoming a big one and protects your profits if a winning investment turns against you. There have been countless times that I gave up hard-earned gains and watched them become losses because I didn't set a stop. Even worse, I allowed manageable losses to turn into gaping holes that hemorrhaged money... all because I was sure I was right about what a great stock I had bought. The Oxford Club generally recommends a 25% trailing stop, but with more active trades, I typically will start to tighten the stop as the stock rises to protect my gains. (To learn more about trailing stops, go here.) Lesson No. 2: Don't invest more than you can afford to lose. There are few feelings more sickening than realizing you've lost more money than you can afford to lose. If you can only afford to lose $1,000 in a stock and you're using a 25% trailing stop, you shouldn't buy more than $4,000 worth of shares. On the other hand, if you're trading options (which are too volatile for stops), you should assume that if the trade goes bad, you'll lose 100% of your capital. That usually won't happen, but it is a possibility, so you'll want to manage your risk accordingly. In other words, if your maximum acceptable loss is $1,000, don't buy more than $1,000 worth of options. This strategy isn't just beneficial for protecting your downside. It allows you to take big swings as well. I've had various investments throughout my life - including stocks, options, and real estate - where my bet was small enough that it wouldn't have a significant consequence, but if it did well, it would still move the needle in my portfolio. |
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