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Hi Lion,
If you bought at $10 and sell it for $9.50, why is your pain below at 10% instead of 5% arithmetically in the said example?
In stock trading, it is a good practice to set your stop loss at 20-25% of the stock price, so as to make it mechanical, with no emotions. Target is 100% or with trailing stop, once the market is in your favor. Usual or normal daily stock price flutuation is between 1-20%. So, if your stop loss is between this range, you will be wipsawed right & left.
To have this stop loss, one must have a robust trading system, which can give proper buy/sell signals in min 60% of the time. One must learn or manage to control the market rather than the other way round, unless you want to turn short term trading to long term investment, as in buy & hold or hope.
It is the sentimental nature of stock markets to fluctuate daily and how should one manage this fluctuation, so as to overcome one’s emotion in trading. Do you not agree?
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Hi James,
The percentages are just arbitrary. Can’t really measure them but my point is more to show that initially, the pain of cutting is more compared to the pain of holding on.
Anyway, just a side note. According to prospect theory, losses have more emotional impact than an equivalent amount of gains.
This is because people value gains and losses differently. Thus, if a person were given two equal choices, one expressed in terms of possible gains and the other in possible losses, people are more likely to choose the former – even when they achieve the same economic end result.
http://www.investopedia.com/university/behavioral_finance/behavioral11.asp
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Human beings are emotional creatures and I am one who can’t bear to cut loss.
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As what Rod Stewart sang “First cut is the deepest…” and yet…
Well, to this day, I am still haunted by when to cut loss and sometimes when I do, the price reverses. There are occasions when I told myself I’m lucky to cut loss. Anyway, no easy answer and part of the problem is the high commission costs. Just cannot afford to enter and exit frequently or else the commission costs would become a huge expense. Just adding up commissions alone over a year will tell you how much you ‘loose’. Just like the casino; you ‘loose’ $100 even before you put on a bet. Well, I guess that’s the price to pay for entertainment. For some, it’s more thrilling than F1.
P.S. Don’t mean to pick on numbers but I don’t quite understand how sell pain and loss pain are not the same; e.g. 0.5 loss out of $10 should be 5% for both hold and sell?
ReplyHi Jack,
It’s just some hypothetical numbers to illustrate my point.
At the initial loss, the pain for selling is actually higher than the pain for holding on, so most people will hold on. This is because when you sell, you realize the loss. If you hold, the loss is still a “paper loss” and there is hope that it will not be an actual loss eventually.
ReplyAh I see.
An even greater pain is when you sell at a loss and the price reverses dramatically.
Slowly coming to grips with this….
Thanks Lioninvestor.
Yes, that is why “realising” a loss will usually give a higher pain than holding on, as we will be afraid that the price will reverse after we sell.
It is only when the price has gone down so much that we will just start to extrapolate the future price movement downwards. At that point, it makes sense to sell as holding on means a lower price and more pain.
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