Every stock trader will take losses at some time or another. That’s a given and everyone who dabbles in any financial market needs to accept that fact. What’s important, especially for retail traders, is not the loss itself but the response to it.

The most common response (after swearing) is to hang onto the losing position and hope that it will recover. Some traders even increase their position, telling themselves they’re “buying on the dip” or “short selling on the hop.” But technical traders adept at their craft will recognise that response as an emotional one rather than the cold logic demanded by financial markets. In short, such doubling down is wishful thinking and a trap.

Note the chart below:

Alert traders may recognise this as the weekly chart of Leighton Holdings Limited (LEI) for parts of 2006 and 2007. Those were bull market times, when little more than a pulse was required for earning profits in stocks. In early 2007, LEI doubled its value, retraced slightly for profit taking, and then rose again by the same percentage. The stock rose from 20.00 to above the 60.00 level in less than one year.

And then it formed a double top.

This was a lovely trade, highly profitable and technically charming, with its textbook retracements at the 50% and 100% levels. Any trader would be forgiven for not wanting to see it come to an end. But the global financial crisis had begun rumbling in the background of financial markets, both UBS and Merrill Lynch had announced massive losses and exposure to toxic assets, and the largest central banks were coming together to coordinate interest rate cuts and emergency funding operations.

The double top in that scenario could be viewed as an emergency exit signal. As 2007 ended, like most other stocks around the world LEI reversed into a downtrend, and by the end of 2008, it had returned to the 20.00 level—all profits gone.

The important points are, a) stop losses should be utilised by all retail traders, no matter how bullish the market or certain the trade, and b) traders who cut their losses at the double top’s neckline, before the collapse intensified, managed to avert disaster (and possibly shorted the stock on its way down). The traders who lost the most were those who held onto their positions and kept waiting for the market to turn.

It’s possible they’re still holding on today.

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