No trader can ever expect to be correct in every one of his market transactions. No individual, however well he may be grounded, no matter how much experience he has had in practical market operation, can expect to be infallible. There will always be mistakes, some unwise judgments, some erroneous moves, some losses. The extent to which such losses materialize, to which they are allowed to become serious, will almost invariably determine whether the individual is to be successful in his long-range investing activities or whether such accumulated losses are finally to wreck him on the shoals of mental despair and financial tragedy.

THE TRUE TEST

It is easy enough to manage those commitments which progress smoothly and successfully to one’s anticipated goal. The true test of market success comes when the future movement is not in line with anticipated developments, when the trader is just plain wrong in his calculations, and when his investment begins to show a loss instead of a profit. If such situations are not properly handled, if one or two losing positions are allowed to get out of control, then they can wipe out a score of successful profits and leave the individual with a huge loss on balance. It is just as important-nay, even more important-to know when to dessert a bad bargain, take one’s loss and count it a day, as it is to know when to close out a successful transaction which has brought profit.

LIMITS ARE A MUST

The staggering catastrophes which ruin investors, mentally, morally, and financially, are not contingent upon the difference between a 5 percent loss limit and a 20 percent loss limit. They stem from not having established any limit at all on the possible loss. Any experienced market operator can tell you that his greatest losses have been taken by those, probably rare, instances when he substituted stubbornness for loss limitation, when he bought more of a stock which was going down, instead of selling some of it to lighten his risk, when he allowed pride of personal opinion to replace conservative faith in the cold judgment of the market place.

SNOW BALL EFFECT

It may be hoped that the reader will recall specific illustrations where his losses were large, then resolve at this point on in the future that at least some sort of mental limitation is used in all of his market trades. The chief aim of a loss limitation is to provide mental ease and peace of mind through the whole period of the transaction. If the stock position advances, the trader can take his profit whenever he desires, preferably at a point that was established at the time of purchase. But if the stock declines, he simply lets it decline, hoping it will reverse before it hits his stopping point. But he is not particularly disturbed, simply because he is not forced to make any further decision in the matter. The loss has already been determined; therefore, it will not be allowed to get out of control.

PLAN FOR THE WORST

The entire efficacy for establishing a loss limitation before actually making a commitment revolves around having a definite plan in view for every transaction. The importance of building such a campaign in advance of each trade cannot be overemphasized. Too many individuals buy first and plan their campaign afterward. It is much easier to buy than to sell. It is easy to calculate profit should a stock go up, but much more difficult for the average trader to concentrate his attention on the possibility that the stock may go down instead of up. If he waits until he has a loss before that decision, his judgment is almost certain to be warped and be clouded by such loss. And the longer he waits and the greater the loss becomes, just so much greater becomes his mental confusion and his inability to take proper action. To say that a decline is impossible is to fool oneself. What will the trader do if it does go down? Has he planned for the worst ahead of time?

SIMPLE IS TAKEN FOR GRANTED

Simple, logical rules are at the heart of this thought process. But far too often they are ignored, taken for granted and overlooked, perhaps because of their very simplicity. Yet they lie at the very foundation of stock market success and profit. They are as fundamental to trading as profits are to a company’s balance sheet.

The above has been gleaned from Mr. Schabaker’s classic Stock Market Profits.