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Profit and Loss Plan

The Importance of a Profit/Loss Plan
Every trader who is serious about trading knows the importance of a profit/loss plan.  Trading is not about buying low and selling high although we all would like to think that in a perfect world.  It would be nice to buy at the low and sell at high but let's get real it is nearly impossible to do that on a consistent basis if ever. All traders are human and suffer from the emotions that tend to sway our judgment and it is in our nature to hate losing. Taking a big loss on a stock is not only detrimental to our bottom line it also hurts our egos. 

Time and time again novice traders take profits by selling a stock that has appreciated in price but for some reason they tend to hold losers in hopes of a rebound. They hold onto this declining stock until their investment shrivels to a fraction of what they originally paid. They do just the opposite of what they should do.  They sell the winners and keep the losers and wonder why their bottom line continues to decrease.  The professional trader will cut the losses immediately and let their winners run.  This is how fortunes are made in stocks.  Nickel and dimming for small profits are for the amateur traders not for the serious trader who trades for a living.  One solution we have to solve this problem is to adapt a disciplined profit/loss plan.  The profit/loss plan is a set of limits that determine the maximum loss or gain an investor will take on a stock. Containing losses is the most important part of any trading plan and is crucial to a sound strategy. 

We all make mistakes and get into trades that go the wrong way.  All of us have lost money in the stock market at some point in our trading experience.  What sets the good traders apart is their ability to recognize their bad trades and get out of them before any serious damage is done.  A profit/loss plan helps you recognize your mistakes by allowing you to separate your emotions from your trading. Trades should be recognized as simply a vehicle to increase your cash flow not build your ego.  If you look at them in that light it will be much easier for you to let go of your losses and therefore control them. 

Devising Your Plan
One factor that you must consider when devising your profit/loss plan is your risk tolerance.  Your risk tolerance will depend on factors such as your personality your time frame and your available capital. 

Carrying Out Your Plan
Once you have decided on your numbers whether they are conservative or aggressive you have to put the plan into action with as few hitches as possible. Remember this plan has a double requirement. You must sell your stocks: 1.) If they fall to a certain level and 2.) If they rise to a certain level you have to set a trailing stop to lock in the profit.  

The stop loss ensures that you will not get burnt on a down market especially if you are not able to watch it every second. When you enter in your order with your broker set the stop price at your maximum loss percentage and then sit and wait. If the price ends up appreciating to your upper boundary adjust your stop up to protect your profit. 

Staying Disciplined
You will have to remember that the whole idea of the plan is to establish strict guidelines for when to sell. Sure it hurts to see a stock continue to rise once you have sold it but it is often better to sell on the way up than to wait until you have to dump the stock while the price is collapsing after its peak. 

Things to Remember
Please keep in mind that our example figures are generalizations. Devising your plan requires detailed research analysis selfassessment and a realistic outlook. 

Here are some things to remember:
A stock that declines 50% means that you will need to double your money (a 100% gain) to break even. Controlling losses is key to sound investing. 
Making mistakes is human nature. Once you realize this you will find it easier to move on. 
Buying a stock and holding onto it for a very long time does not mean that you will make money. The Buy and Hold strategy will work if you monitor the stocks through each stock market cycle and know when to sell them. 
The most important part of devising a profit/loss plan is sticking to it!

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