Rule #3 – Never, ever, ever lose more than 10% on any single trade.
Traders, finance professors, and common sense all say that you should never let one sour apple ruin all of the other apples in your basket! Picking 9 stocks that gain 10% will be a waste of time if your 10th stock loses 100%, so DON’T LET THIS HAPPEN TO YOU! Having 9 stocks that gain 10% and one stock that loses 100% still results in a net LOSS of 1%!
The easiest way to follow this rule is to place a stop-loss order on your stocks as soon as you buy them. If you buy IBM at $100 a share, then immediately place a stop loss order at $90. This way you will be able to sleep at night and not have to worry about a market crash erasing more than 10% of your portfolio value in any given day, week or year.
Placing a stop loss order or a trailing stop at 8 to 10% below your purchase price is a routine you must practice religiously. William O’Neill, the father of technical analysis and the founder of Investor’s Business Daily recommends the 8% point, but others say 10%. Yes, you will get burned at times. If the stock falls 10%, you get stopped out, and the stock may recover. But more often then not, a stock that falls 10% will continue to decline even further. Sure, it’s OK to buy the stock back later at the cheaper price, but don’t buy it on the way down, wait until it has bottomed, formed a base pattern on the chart, and then shows signs of life again.