Why Losses Are More Important Than Gains

It's only January, but many traders and investors have already incurred substantial losses after playing the long side too aggressively. Fortunately, it isn't too late to take a giant step back and get things back on track for 2009. The quickest fix in this regard is to review, rethink and retool the loss side of your current market strategy.

In many ways, attention to loss is a sign of experience while attention to profits is a sign of immaturity. Talk to any professional trader, and you'll notice their capacity to forgo marginal positions and wait for the low-hanging fruit. These folks also keep one eye on the downside at all times so they know exactly what's they'll lose if they're wrong.

New traders are focused on making money, but it's a huge mistake. Risk, not reward, determines profitability in this computer-driven environment. Ironically, chasing profits interferes with the timing needed to get into the market at the most advantageous price. Many times, this is a contrary dynamic that requires buying when others are rushing to sell, and selling when others are running to buy.

Total concentration on risk marks the boundary between a trading professional and a trading amateur. Of course, risk isn't as sexy as throwing money at a hot stock or selling short a cold one. But we need to examine our priorities when it comes to the trading game. Are you interested in the adrenaline rush, or do you want to make money?

Working the loss side of your trading plan starts with the acute realization that the market is a very dangerous place. After you get recognize that ugly fact of life, the following strategies and techniques will become highly intuitive in your day-to-day activities.

---

At the time of publication, Farley had no positions in stocks mentioned, although holdings can change at any time.

Please note that due to factors including low market capitalization and/or insufficient public float, we consider Salix Pharmaceuticals to be a small-cap stock. You should be aware that such stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices.

Farley is also the author of The Daily Swing Trade, a premium product that outlines his charts and analysis. Farley has also been featured in Barron's, SmartMoney, Tech Week, Active Trader, MoneyCentral, Technical Investor, Bridge Trader and Online Investor. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks.

Farley appreciates your feedback; click here to send him an email. Also, click here to sign up for Farley's premium subscription product, The Daily Swing Trade, brought to you exclusively by TheStreet.com.

TheStreet.com has a revenue-sharing relationship with Trader's Library under which it receives a portion of the revenue from purchases by customers directed there from TheStreet.com.