Dear Student
The Nasdaq closed at a new record high yesterday…
Bitcoin broke $72,000 (and my key target of $69,500) as well…
And the Dow and S&P 500 are up right now after reaching their all-time highs less than two weeks ago.
But just because the markets are hitting home run after home run doesn’t mean that your trades will be a grand slam, too.
Let’s face it…
There’s no strategy, system, or holy grail in the investment world that works 100% of the time. And if anyone ever says there is – RUN! And run fast!
That’s why today, I want to focus on taking losses – and adjusting losing trades.
Let’s get started…
How to Fix a Losing Stock Position
So, you bought a stock, now it’s falling – and you’re just standing by, watching the money drain from your account.
I’ve been there before. Anyone who has spent a decent amount of time in the market has been there before.
But there’s one thing that separates the good traders from the bad – and that’s knowing how to get your position out from under water.
Now, first things first: You only want to fix a losing stock position if you believe the stock will rebound and continue to rise. If you think
the stock is destined to fall, then you need to get out immediately. Just sell the stock and take the loss. It’s always smart to preserve capital for the next trade.
But if you think the stock has still got some juice, then you’ll want to fix it. And to do that, there are three things you can do…
Wait.
Basically, this involves doing nothing but sitting around, waiting, and hoping for the stock to go back up. Now, in my 30-plus years of experience, this hasn’t worked. And if it worked for you once, it likely won’t again. This is essentially surefire way to have a front-row seat to the draining of your trading account.
Double Down.
The double-down approach involves adding more money to the trade at a lower price in hopes of bringing your breakeven down. Let’s say you bought 100 shares of XYZ stock at $70 per share for a total investment of $7,000.
Your total risk would be your initial cost: $7,000. And your profit potential is limitless, moving up alongside the stock. Your breakeven is $70 – the price at which you bought the stock.
But after buying these 100 shares, the stock falls from $70 to $50. Using the double-down approach, you would attempt to lower your breakeven by buying into the stock as it drops.
So, say you buy 100 more shares, this time for $50 each, bringing your investment to $5,000 – which, added to your original investment, brings your total to $12,000. You lowered your breakeven, sure. But, in the process, you added more cost and risk to the position.
Now, you can’t just lose $7,000 – you can lose up to $12,000.
That’s why I wouldn’t recommend waiting or doubling down… Because the third route involves lowering your breakeven as well – without spending an extra penny.
Fix It.
This is the best way to fix a losing stock position – turn to options.
Once the stock drops, buy one at-the-money (ATM) call while simultaneously selling two out-of-the-money (OTM) calls. Essentially, you’re robbing Peter to pay Paul. The premium you receive for selling the OTM calls will pay for the ATM call, creating a zero-cost trade that you can layer on top of the stock price.
Let’s take the same example we’ve been using. You bought 100 shares of XYZ stock for $70 per share. Then the stock drops to $50.
ATM means that the option’s strike price is the same as the stock price. So, you purchase a $50 call on XYZ stock. OTM means that the strike price is more than the stock price. In this case, you’ll want to set your strike at the price you originally paid for the stock – $70. You’re selling two $70 calls on XYZ stock.
The $50 call will run you about $7.00, or $700 for control over 100 shares. At the same time, selling the $70 calls will hand you $3.50 each, or $350 per contract, bringing your total income to $700 – creating a free trade.
Now, let’s layer this trade over your stock position in the risk graph below:
The dotted line is the original position, and the bolded line is your new, free trade. As you can see, we’ve lowered the breakeven to $60 – without increasing the risk or spending any additional cash.
Now, there’s is one disadvantage. Your option trade has a capped profit, while the original stock position had an unlimited profit. But remember – when a stock is falling, turning your position into a loser, it’s not the time to be greedy. When a position goes against you by several points, you shouldn’t be worried about profits. You should be worried about saving money – exactly what the Fix-It approach does.
And before we wrap up, there’s one more thing I want to cover that often goes hand in hand with losses…
Negativity
Negativity exists in all aspects of life – and trading’s no different. Whether it’s a losing trade or outside influences making you doubt yourself, there will be times of negativity. Do you think Warren Buffet made it to where he is without ever taking a loss… ever doubting himself? The key is how you handle negativity.
And these are my rules:
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Your best tool against negative influences is your system.
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Being consistent in your trading means consistently following your rules.
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As a consistent trader, place your orders each day at the same time.
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Through consistency, negative influences go away. Follow through on scheduled assignments, such as order entry, exit, and adjustment.
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Plan your trades and trade your plans to facilitate consistency.
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Use a trading partner to achieve consistency in your trading.
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Fear and greed are the enemies of consistent trading.
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Your commitment to consistency blocks greed from attacking your goals and objectives. Set realistic goals and expectations to combat fear and greed.
The key to your success during times of negativity is this: POSITIVITY.
Stay positive, block out the negativity, learn from the experience – and move on. It sounds simple because it’s as easy as that.
To your continued success,
Tom Gentile
America’s Pattern Trader