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How to maximise profits and minimise loses in the stock market?

March 21, 2020

One of the best tips for investing is: “cut your losses and run your profits”.

This axiom is easy to understand but hard to execute. There are several reasons why it is difficult to implement.

Human Psychology

Human psychology plays a significant part in portfolio management. Behavioural finance was born when psychology concepts were used to explain finance phenomenon. Here are the top 2 reasons.

Overconfidence

Faced with a loss-making position, many people suffer from overconfidence especially when the position was entered after significant analysis has been done on the position and the reputation of the proponent of the investment is at stake. The result of this is the reluctance to accept one’s mistake.

Underreact to new information

The slowness in accepting that the circumstances for making the investment have changed despite receiving new information is largely due to the human’s underreacting to the new information. So, a loss-making position builds up further despite receiving information that it has been a wrong decision. This is related to the anchoring effect which typically leads the investor to stick to the initial investment entry price.

Inconvenient, repetitive and is a hassle

It is impossible to monitor the portfolio manually, especially when the portfolio is invested throughout the world. It is also inconvenient to instruct representatives to do so on our behalf when we also hold full time jobs. Most people would then resort to placing limit buy/sell orders for the portfolio themselves. However, this is repetitive and is a hassle. So, this is often neglected over time.

How Crea8 helps

No psychological influences

Crea8 adopts the investment policy (including risk management) systematically and consistently. Crea8 obviously will not be influenced by psychology and would be able to assess the investment opportunity objectively and systematically; and make the unbiased decision.  

Automate to reduce hassle

Crea8 automates the placing of cut loss and take profits orders. Crea8 scans for accounts where there have not been any cut loss or take profits orders placed. Using client specified take profit or stop loss levels, Crea8 is able to compute the appropriate cut loss and take profits orders.

Use smart orders

A normal limit order is not suitable for maximising profits with cut loss in mind. This is because the limit order is not adjusted upwards when the stock price increases. As a result, the cut loss limit order becomes out-of-date. 

For example: let us say the initial price is 100 and cut loss is 10. Hence the cut loss order to sell the position is 90. If the price subsequently rises to 120, the cut loss limit order remains at 90. Hence, the stock would have to fall by 25% to reach 90. 

Instead, Crea8 adopts a smarter order which would revise the cut loss limit or market order as the stock increases from 100 to 120. Then when the stock peaks and turn at 120, the cut loss limit or market order remains at 110. If the price hits 110, then the position is cleared. As a result, the investor pockets 10 profit instead of nursing a 10 loss. 

Warnings and limitations of use

Like all orders, Crea8’s smart cut loss method above is not without its limitations when markets are volatile.

No guarantee in execution price during volatile or illiquid markets

Whilst the abovementioned mechanisms work under normal market conditions, execution is not guaranteed especially in volatile and/or illiquid markets when there are no buyers or sellers.

Triggered unnecessarily

Cut loss orders may be triggered by a sudden sharp move in price that might be temporary. If the cut loss order is triggered under these circumstances, the investor may buy or sell at an undesirable price. This is mitigated by using limit orders (which executes at a specific price) instead of market orders (which executes at the market price). However, there is the possibility that the order will not be executed by limit orders.

Crea8’s Advice

Notwithstanding any limitations caused by volatile and illiquid markets, it is important that your portfolio is monitored between the portfolio rebalancing dates.

Crea8 monitors your portfolio by automatically placing cut loss and take profits orders or reminding you to do so. This is a crucial but often neglected risk management process when managing a portfolio. 

So, let Crea8 help you manage the risk in your portfolio.

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