1. Money
You can opt-out at any time. Please refer to our privacy policy for contact information.

Losing Is Your Key to Making Money in Stocks

It's Not the Number of Wins but the Amount of the Wins

By

broker watching stock and holding phone
Yellow Dog Productions/The Image Bank/Getty Images

From the time we are little children we understand that it is much more pleasurable to win than to lose.  Every fiber of our being wants to cross the finish line first, not just occasionally, but every time. It is not in our nature as human beings to get comfortable with losing.

However, if you are going to be successful in the stock market you not only need to get comfortable with losing, you need to embrace it.

The uninitiated investor will assume that they have to be right, or win, on the majority of their trades in order to profit in the stock market, but what is more important than the number of times you win is the amount you win on those trades.  Learning to take small losses -- a lot of small losses -- and letting your winning trades run is the key to long term profitability.

It's really not a mystery as to why this works, in fact it just comes down to simple math.

Imagine if you were to take ten different positions in ten different stocks and you had decided to risk a maximum of one-hundred dollars per position. The would mean that the total amount that your could lose would be one thousand dollars.

If you were to lose on half of those positions you would be down five hundred dollars and would have to make a total of five hundred dollars -- or an average of one hundred dollars per position -- on your five winning trades in order to break even.

Now let's assume that you were able to make one hundred and fifty dollars on average for your winning trades.  You would then only need to win on four trades -- for a total of six hundred dollars -- against your six losses in order to break even. 

Now let's take it up a notch.  Let's assume you were able to make an average of three hundred dollars per winning trade.  In that scenario you would only need to win on three out of your ten trades -- or thirty percent -- in order to make money.  Three times three hundred equals nine hundred dollars in wins against seven hundred in losses, for a net profit of two hundred dollars.

What the math here is illustrating is that the quicker you take your losses and the more you let your winners run, the fewer number of trades you need to be correct on in order to turn a profit.

Even the best Wall Street traders have a hard time maintaining a fifty percent win rate over time. They understand that just by the nature of the game they are going to lose on more trades than they win on.  They accept this fact, which makes it easier to quickly cut losers, realizing that goal at the end of the day, or month, or quarter is not to have the best winning percentage, but to have the highest amount of profit in their brokerage account.  

Though it runs counter-intuitive to our nature, allowing yourself to lose often in the stock market will ensure that small losses don't turn into big ones and that you will always have your money moving into the best stocks.

Photo Credit: Jeffrey Coolidge/Stone/Getty Images

 

 

©2014 About.com. All rights reserved.