This Simple Rule Keeps One Bad Trade From Destroying Your Account

Over the years, I’ve told my readers a decent amount about my personal life.

Like how I used to be a financial advisor… or how I traveled the world during (and after) college. I’ve even shared stories about my hometown in rural Idaho — and how I spent my summers guiding wealthy clients on river rafting and fishing trips.

But one thing most people may not know about me is that I don’t speed when I’m driving. Ever.

I just don’t see the point in it.

Of course, occasionally I many not realize how fast I’m going. I might even fail to notice a speed limit sign. But for the most part, I just don’t speed. The risks outweigh the reward.

Most folks speed if they’re running late, thinking they will make up lost time. Sure, you may make up a minute or two. And you may get away with it many times before you’re caught. But is that extra minute you might make up worth getting a speeding ticket? If you get pulled over, not only will you be extra late, but if the cop ends up giving you a ticket, now you are out time and money. Plus, these things often happen at the worst possible time…

It’s that simple. To me, the risks of speeding outweigh the reward. So, I do my best to stay within the speed limit.

This is just how I tend to think about things. Whenever I’m involved in something, I tend to analyze every single possible outcome before making a move. My wife thinks I’m weird for this, but I don’t mind… It helps me understand the world – and more often than not, it leads to a rational decision-making process that works out pretty well.

This kind of thinking comes in handy especially when it comes to stocks.

I’ve spent the past decade-plus thinking about the risks associated with stocks. In other words, risk versus reward. But contrary to what most people think, there’s a lot more to the calculation than simply buying or selling.

Allow me to explain…

The Risks Associated With A Winning Streak

Everybody assesses risk differently, whether we’re talking about speeding or the stock market.

Unfortunately, when it comes to stocks, many investors assess their risk as if they must do 80 mph in a 55-mph zone in order to be successful. But that couldn’t be further from the truth.

My longtime readers know that we spend plenty of time talking about picks that have big-time, life-changing potential. But I talk more about risk management – that is, avoiding losses – far more than I do about finding that next big winner. That’s because if you take too big of a loss, you won’t have enough capital to put towards that next big winner.

That’s why I talk about the importance of having things like trading rules and sell signals in place. They curb your risk and keep losses small — but only if you actually use them. But I’m convinced that most investors could improve their performance dramatically by simply getting out of losing positions early.

So today I want to talk about another risk that can easily creep up on us, especially during periods when the market is doing fantastically well.

To understand what I’m talking about, think back to 2019. The S&P 500 returned nearly 30% that year. When you have a year like that, nearly everything you touch has a good chance of making money. And that was certainly true for us over at Capital Wealth Letter, my premium advisory service.

When the market behaves like this, we tend to become overconfident. All of a sudden, every investor and trader thinks they are a genius. And that confidence can lead them to make some very crucial mistakes. And I’m not just talking about making “riskier” picks, either.

Sometimes we end up investing too much money into one position.

Perhaps you’ve heard of the “2%” rule. It basically refers to the amount of your portfolio you should allocate to each trade. I won’t get into the “whys” or “hows”, other than to say that this can serve to protect your portfolio. It allows you to live to fight another day in the event you find yourself with a total dud of a loser. It’s a pretty good rule of thumb for traders to follow.

But when we are enjoying a lot of success, we feel tempted to inch up our allocation with every trade. That 2% inches up to 3%, then 4% or 5%. Pretty soon we are putting all our eggs in one basket, believing that our winning streak will continue.

Now, that can work well when times are good. But think about that chart of the S&P in 2019. Remember what happened just a few short months later? The Covid-19 pandemic happened.

Closing Thoughts

We all know what happened next. As the market went into a nosedive, some stocks held up better than others. Others were decimated. But like the driver who gets stopped for speeding, some of us learned our lesson, but most of us didn’t. It wasn’t too long before many investors thought they were geniuses as the market went into a furious rally once again.

I’ve been around the markets for a long time. I’ve traded everything from equities to cryptos to futures and more. Take it from me… I’ve been a victim of this line of thinking. And I assure you, the market will quickly humble you if you’re not careful.

When the market is doing well, don’t let the winning go to your head. You will inevitably make a losing trade once in a while. Keep your allocations in check. With each trade, just assume going into it that you may lose money. If you can’t stomach that, then you need to lower your allocation. That’s where the 2% rule comes in.

Remember, it’s not how much money you make, it’s how much you keep. Don’t let one trade blow up your account.

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