The world of trading is not all about investing in stocks for the assurance of getting gains. There will come a time that a stock you may have bought dropped to a price lower than what you paid for it.
Will you be hopeful that the crash is temporary and still hold it with the strong hope it will rise soon?
Will you be panicking and bailout after a crash?
Both of these actions are not real and practical strategies.
So, what do I do when my stocks are crashing?
Stock crashes are natural. It is a risk that you had taken when you decided to enter the stock market.
Here are some simple questions you need to answer to handle your investments in times of stock price crashes:
- Is the reason for buying the stocks still valid? When you believed that a small biotech product will one day succeed in the market, you bought the stock. Then came a period when you noticed that the small biotech firm’s stock price has been crashing. If you are having difficulties deciding whether to retain or maintain possession of the stock. You can ask yourself if your reason for buying the stock is still valid.
If not, then you might want to let go of it as soon as possible. Despite saying that you admire the stock so much, if the reason for buying it is not there anymore, then it is better to just let it go.
- What is my “point of maximum pain?” In this second question, you need to know how much loss do you need to get before it becomes painful for you as a trader.
Before you grab a stock, you should first define which point of loss you can tolerate until it hurts you as a trader. This method is helpful because you get to plan without having your emotions get in the way of you making rational decisions during stock crashes.
For example, I bought the iShares MSCI China Large-Cap Fund (NYSE: FXI). China stocks have an attractive price compared the U.S. stocks. It means that my reason for buying the stock is its low price. Also, when the situation goes from bad to less bad for the stock, then earnings can be realized from the investment.
I set a 25% ‘trailing stop’ for this kind of trade. This is an example of maximum pain.
What does this 25% ‘trailing stop’ mean?
If my China fund falls below a certain value, I will sell it the following day. There are no ‘ifs’ and ‘buts’ if it reaches that point.
If the value of the China fund is too low, it is close to its trailing stop. If it reaches the trailing stop, I will sell the stock or buy a protective put. No ‘ifs’ or ‘buts.’
The relevant thing from this example is the presence of an exit strategy. With a plan, you will not need to panic when the crash comes.
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