When Should You Cut Your Trading Losses?

When to Cut Trading Losses

The fear of losing money prevents many people from ever trading or investing. Trading newcomers usually end up with heavy losses at some point, and losses make beginners quit. It’s not hard to understand why. It’s well known that losing money sucks.

When to Take a Loss

Not all trades will be winners and you have to be okay with that. Trading is about taking calculated risks. You’re risking your money for the reward of more. Losses are an unavoidable part of trading, even for experts. It isn’t for the faint of heart and it’s rarely easy to sell a losing stock. 

Fortunately, there are methods that can limit your losses and help you overcome your attachment to them. 

So when should you cut your trading losses? Unfortunately, there isn’t a one size fits all answer. There are, however, certain guidelines that you can follow depending on your trading strategy.

Different Methods for Different Trading Strategies

Ideally, for all kinds of trading, you will “cut your losers short and let your winners run.” How quickly you cut your losses should depend primarily on your trading strategy. If you cut a loss at 5% that may be too soon for options trading or some methods of swing trading. Cutting at 5% is definitely not soon enough for day trading or scalping.

It’s more than just setting a stop loss and hoping things go your way. You’ll need to identify chart patterns and pay attention to technical indicators.

Picking the perfect entry isn’t easy. A trade might start to turn on you at first, but it doesn’t always mean it’s a bad trade. Your entry could be off by a small percent or you could be flat out wrong. That’s why you must identify areas of support and make an exit plan before you place the trade.

I’ll cover each trading style to help better pinpoint when you should cut a trading loss. If you feel more comfortable taking a loss sooner/later than what’s suggested for your trading method, that’s completely fine. You’ll learn why your personal strategy and plan matter the most when it comes to realizing a loss.

Day Trading

When it comes to day trading, you are going to want to cut your losses as soon as possible. Better yet, if you feel things are off, try to get out with a small to medium gain.

You’ll need to give each trade your full attention to better decide when to exit.

Placing day trades requires constant analysis. You’ll want to stick to short time frames and determine areas of support and resistance. Once prices move against you, start to plan an exit before the price reaches your stop loss.

If you are looking for a percentage method to set your stop loss, keep it around 1-2%. This doesn’t mean every time you day trade set your stop loss at these levels. You should always plan your exit before the trade and measure the risk to reward ratio.

You don’t consistently need huge wins to be successful at day trading. You’ll make it in the long run if you just win more than 50% of the time.

A small profit is always better than a loss, even if you leave money on the table.

Options Trading

There are many different strategies when it comes to trading options. You can day trade, swing trade and buy/sell long term options (leaps).

Day trading options share most of the same rules discussed about day trading stocks. However, options will fluctuate a lot more than stocks, especially those that expire in the near term.

If you are day trading options, your stop loss using the percentage method should not be 1-2%.

When you should take a loss on an options trade depends on the type of options you are buying or selling. You should cut your trading losses quickly on short expiration contracts.

If you are day trading calls or puts, setting a stop loss around 5-10% will give you more room. Again, that is just a general guideline for those seeking to use the percentage method. Getting out of an options day trade before it turns into a loss is ideal.

Swing trading options means you are buying to hold for a few days to a few weeks. Follow the charts closely and make an exit plan before you enter the trade. It’s not uncommon for options traders to hold through losses of 20-40%.

Buying long-dated options (leaps) gives you more time to hold and hit your profit target. Using the percentage method, you can set a stop loss anywhere from 10-40%.

If you don’t take a loss at 50% on an options trade, you’ll likely hold till it expires worthless or miraculously flips in your favor. If you find yourself doing this often, your gambling more than you are trading.

Options trading involves a higher level of risk than trading stocks, make sure you educate yourself before dipping your toes in.

Swing Trading

Taking a loss on a swing trade depends greatly on your trading plan. Short-term swing trading will have similar rules to day trading. Mid to long-term swing trades will be a mix of rules from both investing and day trading.

Using the percentage method when setting your stop loss will vary with each time frame. Here is a list of guidelines to give you an idea:

  • Short-term swing trades cut losses around 2-3%
  • Mid-term swing trades cut losses around 3-6%
  • Long-term swing trades cut losses around 4-15%

Remember, these are just guidelines and you should set your stop loss where you feel most comfortable.

Deciding when to cut your trading losses isn’t as simple as just using the percentage method. You should plan your exits based on major support/resistance areas, RSI, volume and other indicators.

If a stock breaks support, you don’t need to wait for it to hit your stop loss.

Long-term swing trading involves more fundamental analysis than the other trading styles discussed. If you place a swing trade and the stock tanks but the fundamentals haven’t changed, you may want to consider averaging down or holding. If you don’t believe the stock will recover regardless of the fundamentals, then get out.

Long-Term Investing

Investing for the long-term means holding for years and years. You should not be quick to cut losses unless the fundamentals have drastically changed.

Taking a loss on a long-term investment should not be done lightly. Make sure you take time to research the company you invested in. Look into why things have gone poorly and come up with a plan.

A lot can change in 10-20 years. Don’t think of your long-term investments the same way you think of your day trades. Check on your investments periodically but don’t over analyze them every day. Most long-term investors rely on fundamental analysis more than reading charts.

If you don’t believe your investment will ever recover within your time horizon, then it is best to sell. If you don’t want to own it, you don’t have to.

Taking a loss on an investment can be a wise decision. Realizing capital losses will result in a tax credit that can be used to offset taxes on capital gains.

Don’t Be a Bag Holder

Bag holding is the art of stubbornly holding a losing stock because you refuse to take a loss. No trader ever desires to be a bag holder. Bag holders often have a fragile ego and cannot accept the fact that they made a mistake. That, or they can’t come to grips with the amount they’ve lost.

It’s not the end of the world if you are caught with a bag. You’ll just likely miss out on a lot of great trades while you’re waiting for the stock to recover if it ever does…

If you are holding through an unrealized loss because the fundamentals/technical are still intact, that’s one thing. But if you’re holding even though the fundamentals are deteriorating, that’s never good. You should swallow your pride and cut your losses.

Keep Your Emotions in Check

“The markets are unforgiving, and emotional trading always results in losses.”

– Alexander Elder

Losses happen, every trader must deal with losses. Don’t let a loss destroy your self-confidence. Don’t let a loss ruin your day, your week or your trading career. Learn from them and move on.

You have to keep control of your emotions. Dissect your trades and understand what went wrong and what went right. If you emotionally hang on to each loss, it will affect your next trades. Be done with it and try to make your next move a winning one.

Not getting emotional isn’t easy at all, but you will get better with experience. Successful traders develop a positive mindset. After enough practice and time, taking a loss won’t even make you flinch.

Bottom Line

If you’re trying to decide if you should take a loss, ask yourself would you make that same trade today? If so hold on to it, if not then get out of it and move on.

Rely more on technicals and fundamentals when cutting a loss instead of percentages. If the chart pattern is telling you you’re wrong then listen to it. Don’t get in the habit of setting some arbitrary stop-loss and hoping it doesn’t get hit. 

If you are not confident in your trade or you notice it going against you, get out of it before taking a loss. No one ever went broke from taking profits and you can always reassess the trade later.