In stock investment, investors often face this problem when the stocks they buy incur losses. What should be done?

A. Continue to hold and sell only during a pullback.

B. Immediately cut losses to prevent further losses.

Warren Buffett, the investment guru, once said: The first rule of investing is never lose your principal; the second rule is to always remember the first rule.

It can be seen that to achieve success in the stock market, one must learn to preserve their principal. The way to ensure the safety of the principal is to learn to cut losses.

This article will teach everyone a common selling strategy: the 7%-8% cut loss strategy.

Why cut losses?

Cutting losses involves setting a price as a stop-loss point. When the price drops to the stop-loss point, it is sold to stem the bleeding and prevent losses from widening.

Everyone understands the reasoning, but for many investors, setting a stop-loss is very difficult; it all boils down to human nature.

• Stop-loss means that this trade is losing money. The fear of loss is much stronger than the gain, and setting a stop-loss feels like cutting a piece of flesh from oneself, which is why people jokingly refer to stop-loss as cutting meat.

• A stop-loss means denying one’s previous decisions. Not wanting to admit wrong is part of human nature, and accepting that one was wrong is a very difficult thing.

However, if one does not set a stop-loss when the stock price falls, believing that waiting a bit longer will cause it to rise, the stock price often goes in the opposite direction, leading to deeper losses and becoming increasingly passive.

For example, Xiao Ming has always been bullish on Tesla's development and wants to use technical analysis to find a suitable low point to Buy.

At the end of 2022, Tesla's stock price experienced a decline. Xiao Ming found that the stock price had fallen to a previous Resistance level, where a spinning top appeared, and the next day was a bullish candlestick. Thus, he judged that the trend might reverse, so on the third day, he used 0.01 million USD to Buy Tesla stocks at a price of 206 USD per share.

Initially, Tesla's stock did indeed rise, and Xiao Ming was very pleased. However, the good times did not last; the stock price suddenly reversed and fell below Xiao Ming's cost price, yet he still firmly believed it would recover. Little did he know that Tesla continued to fall lower, and eventually, he couldn't bear the torment of the decline, and at the lowest point of 102 USD, he cut his losses, suffering almost a 50% loss of his capital.

This example illustrates how important it is to establish a selling stop-loss strategy before engaging in Trade.

7%-8% Stop Loss strategy

In the stock market, there are many methods for stop loss, with the most common being the fixed percentage stop loss method. (English: Stop loss at a specific percentage)

The fixed percentage stop loss method involves setting a fixed percentage figure, such as 5%, 10%, or 15%, as the stop loss point. As soon as the loss reaches this percentage, the position will be exited, and this percentage is determined by the individual's risk tolerance.

So, how much should this percentage be set to? The famous author William O'Neil provided his stop loss strategy in his published book "How to Make Money in Stocks":

When the stock drops 7%-8% from the buying price, one should immediately set a stop loss.

For example, if Xiao Ming buys A company's stock at a price of 100 USD, according to the 7%-8% stop loss strategy, when the stock price drops to 93 or 92 USD, Xiao Ming must sell the stock.

• Advantages: Simple operation, can reduce emotional impact, controls overall investment risk, and avoids expanding losses.

• Disadvantages: It can lead to frequent stop losses, missing out on subsequent rebounds.

In a bear market or a volatile stock market, you can choose to stop losses earlier, for example, setting the stop loss ratio at 3%-5%.

Why 7%-8%?

You may ask, why 7%-8%, instead of 10% or 20%?

This is based on the experiences derived from William O'Neil's research on the U.S. stock market over the past 130 years.

Historical Data shows that if your entry point is an ideal buy point, the decline of Stocks generally will not exceed 8%. Once it exceeds this limit, it might indicate that there is a problem with the buy point you chose:

• Either the Stocks you selected are incorrect, or there are issues with the company or the Industry.

• Or the timing you chose is wrong, and the market starts to decline again.

For retail investors, in most cases, you can only see that the Stocks are continuously falling, and you do not know the reasons for the decline nor when it will stop.

At this time, a mandatory risk management measure is required to avoid incurring larger losses. The 7%-8% stop-loss strategy limits losses to 7% or 8%, ensuring that no greater loss occurs.

How to apply this in practice?

Let's take a look at these two situations:

• Stock price keeps falling: Assume the buying price is $100. When the stock price falls to $92 or $93, the stop-loss strategy is triggered, and one should Sell the Stocks.

• Stock price rises first then falls: Assume the buying price is $100. The stock price first rises to $130, then drops 8% to $119.6, at this point, the stop-loss strategy is not triggered because there is still a profit. In this case, one should consider the profit-taking strategy.

Returning to the example of Tesla:

Assuming Xiaoming formulated a 7%-8% stop-loss strategy before the Trade, and his buying price is $206, then his stop-loss position should be between $189.5 and $191.5.

When Tesla Stocks drop to this position, if he strictly follows the trading plan and sells the Stocks, he can avoid nearly 50% losses.

What to do if the Stocks rebound immediately after Selling?

Some investors might ask, what if some Stocks rebound right after Stop Loss and even rise higher, feeling very upset and as if they have missed out on billions? What should be done?

In fact, you can view this from a different perspective; you can see the Stop Loss as buying an insurance policy, and the 7%-8% capital you lost is the premium paid for this insurance.

Due to the unpredictability of market fluctuations, Stocks in a downward trend could drop by 20%, 50%, or even more. The purpose of this insurance is to prevent you from losing most of your capital.

Of course, after stopping the loss, you can also choose to buy back the Stocks. Similarly, you need to have your Trading plan prepared in advance.

Summary

As the saying goes, while the green mountains remain, there will be no worry about not having firewood to burn.

From the first day investors enter the stock market, they should always remember that there are risks in stock market investment, and one of the most effective ways to prevent risks is to set Stop Loss levels and strictly enforce the Stop Loss discipline.

The 7%-8% stop-loss strategy provides investors with an effective stop-loss approach. However, other stop-loss strategies are also popular in the stock market, and investors should choose an appropriate plan based on their own situation.