Of course, this is a pretty easy rule to follow when you’re making money. If your trade is showing a positive return, you’ll have no problem cashing out the position by the end of the day and taking your profits. That’s only logical.
However, it becomes more difficult to follow this rule if it means cashing out a losing position. For example, let’s say that you bought a stock late in the day at its support level, expecting to sell it as it bounced back up near its resistance level sometime before the closing bell. Yet, for some reason, the stock broke through its support level and now, you’re looking at, say, a $1,000 loss on the trade as the closing looms.
In this case, it will be tempting to hold onto the stock with the hope that it resumes its normal trading pattern at the opening bell, getting you back near even. A voice inside your head will say, “Hey, why close out a losing position that might turn into a winning position if I just wait an extra day?” Ignore that voice! It is the voice of potential financial ruin.
And if you think I’m being overly dramatic, I’m not. I’ve seen the results of what happens to day traders who head this voice. A friend of mine was down about $1,500 in a particular stock one day, which was an unusually large loss on a single stock for him. However, rather than taking his medicine at the end of the trading day, he thought, “Why not hold it overnight and see what happens on the morning bell? It couldn’t get much worse, right?” Wrong!
After the bell, the company reported catastrophic news; accounting fraud, insider trading, you name it. This news caused the price of the stock to drop $50 per share at the market open on the next day. My friend, who was holding 1,000 shares, had seen his original loss of $1,500 balloon into a $50,000 shortfall.
Now, I’d like to say that this is the sad end to the story but it isn’t. Desperate to recoup at least some of his investment, my friend then dumped the rest of his funds into the stock at the reduced price with the hope that just a small increase in the stock would make up for his original loss. Over the next few weeks, the stock fell another 80% in value. My friend was completely ruined. And why? Because he decided to keep a stock overnight to avoid a small loss.
Now, don’t get me wrong. This type of devastation won’t happen every time you overnight a stock. The problem is that it doesn’t have to happen every time, just once is enough to wipe out your entire life savings. This is why discipline is so important in day trading. The discipline to avoid the temptation of waiting “just one more day” can make all the difference.
Fausto Pugliese is the founder and president of Cyber Trading University, a world leader in online education and training for traders and investors in the markets. You can reach Fausto at [email protected] or follow him on Twitter and Facebook.