Cutting losses and running profits
This is one of the big ones. One of trading's 10 commandments as it were. And although it's going to be like teaching many readers to suck eggs it's an important trading tip so I thought I'd document it on the blog.
The tip really can be defined as simply as this... Cut your losses and let your wins run.
The concept behind it is simple. When trading we're pretty much trying to maximise our profits while protecting our bankroll and losing as little of it as possible in the process. Of course, the concept, and the reality of having the discipline to actually do it, are two totally different things. Especially on the taking a loss side of the equation. When in a losing position the temptation is always there to just "hang on" until things turn round, no matter how experienced a trader may be.
There's no need to take my word for all of this though. Let me use an example. One regarding legendary Wall Street trader Jesse Livermore that can be found in the excellent Reminiscences of a Stock Operator. In the book by Edwin Lefevre, Livermore goes under the name Larry Livingstone and, early in his career, has this to say after turning a multi million dollar fortune into comparitively nothing while trading commodities:
"It seems incredible that knowing the game as well as I did and with an experience of 12 or 14 years of speculating in stocks and commoditites I did precisely the wrong thing.
"The cotton showed me a loss and I kept it. The wheat showed me a profit and I sold it out. It was an utterly foolish play....
"Of all speculative blunders there are few greater than trying to average a losing game.... Always sell what shows you a loss and keep what shows you a profit. That was so obviously the wise thing to do and was so well known to me that even now I marvel at myself for doing the reverse."
I can't really improve on that. It sums it all up about as well as it can be summed up! It's dynamite advice and easily transferable to sports trading on betting exchanges such as Betfair.
So that's the concept sorted. What about the practicalities? How do we go about implementing this trading strategy? Well let's take a basic look at each part of the tip - cutting losses and letting wins run.
This really is as straightforward as planning. When we open a position we should know where we are going to close it if the market moves against us. The point at which to set that bail out price is a whole different subject but how we arrive at it doesn't matter for now. The important thing is there should be a bail out point.
This means we should never lose more than a set amount on a trade. Which helps protect our bankroll and leaves us plenty of money to get involved again. Essentially it stops us just staring blankly at a screen as the market price simply runs away from us leaving us facing growing losses. It keeps us in the game. And in control. While at the same time preventing that awful feeling we've all no doubt had where the price is running against us and we're just hoping "something happens" to turn it around so we can get out for a smaller loss or even break even. As the Jesse Livermore example shows though, and as some of my recent results show, knowing all this and putting it in practice are two totally different things. Having the discipline to actually implement the stop loss can be the hardest thing to do.
Letting wins run
This is the nice part! But also has its difficulties. As the temptation to take a profit, any profit, can be large. Long term though we will make far more if we let our profits run. Imagine how much just 5 extra ticks in each completed trade (open and closed) would make to your own trading over 50 trades. Or 500. Or 5,000.
While letting our wins run we are, of course, also trying to protect the profit we've already made. Give as little of it back as possible as it were. One way of doing this is to implement a trailing stop loss. For example, say we've backed something at 1.8 and the price is now 1.6. We might say to ourselves if the price hits 1.7 we'll cut the position drifting against us and take the ten point profit we still have at 1.7. If the price continues to drop however, say to 1.5 we might move our trailing stop to 1.6. And so on.
There's really so much more that can be said and discussed on this subject of cutting losses and letting profits run but in a nutshell that's it. Naturally we should weigh up all the circumstances involving each market we enter when considering exactly how to implement everything. I certainly alter my strategies depending on market conditions. For example, in the recent Twenty20 World cup I was still happy to let wins run but was far more willing to take a quick profit when it was available than I am in, say and ODI or test match. This was simply because of the increased volatility. Of course I was still cutting losses as usual. I guess the point is this. The trading strategy is a winner. But as with all strategies we need to consider how best to implement them in the markets we are getting involved with.
Labels: trading tips