Learn To Cut Your Winners Short
One of the problems that I find with trading today, is that there are a lot of popular cliches that people hold on tight to, considering them to be untouchable in practice and theory, and the act of challenging these popular beliefs will label one as a trading outcast, reject, or even dangerous.
So what are these cliches that I often find irritable and not nearly as applicable as most traders believe they are?
Let your winners run, cut you losers short. Bulls make money, bears make money, pigs get slaughtered. Buy Low Sell high I'm buying for the long-term I'm going to nibble stock "XYZ" Sell in May and Go Away (okay - so maybe there's been some truth to this one the past couple of years) And so many more!
Now there are some that I fully subscribe to, because they are contrarian in nature and people may say they embrace the cliche but not really. For instance, "Buy the Rumor, Sell the News". Most people will swear by this belief, and it is a legit one for sure, but who actually practices it? If you know that some biotech company is about to get FDA approval on the drug and it rises 40% into the announcement, it's only human nature to be curious to see what happens after the announcement. And when it is a favorable decision, every one expects the stock to go through the roof, only to realize instead a massive sell-off ensued.
But for the purposes of this article, I want to focus on one popular cliche that seems to be universally accepted on all accounts, and I think for the most part, the way that it is interpreted is wrong at best and devastating to a portfolio at worst.
And that is...
"Let Your Winners Run and Cut Your Losers Short"
Fifty percent of this expression I agree with because it goes without say, that the fewer and smaller number of losses that you incur, the better.
But the first half of this statement I have huge issues with. Similar to some of the comments I made in yesterday's post (Developing Your Moneyball Trading Goals), this expression is more responsible for trading losses than probably any other statement I can think of.
Here's where this expression breaks down.