Friday, August 22, 2008

Cut Your Losses and Add to Your Winners

You've heard it a thousand times before from experienced traders or even from yourself. Cut your losses short. It's hackneyed and frankly most traders feel they do cut their losses short. I certainly did. I use stop losses (and I don't move them away from my entry). I'm not a crazy man - or am I?

There is a great little ebook I read recently by the "Phantom of the Pits" that talks about this concept. Although there is a lot of fluff in my opinion there are several key points not to be missed:

1) Use a clock when you trade. In other words if you are in a trade you aren't waiting for the market to do "something" (usually take you out at your stop loss) but you are actively looking to exit the market if your trade idea doesn't immediately "prove it" to you. In other words don't sit there and wait until the market does something. Either your trade idea is a "winner" and it moves immediately and significantly in your favor or it is a "loser" and it either moves against you or doesn't move immediately and significantly in your favor. Every minute, hour, day you are in a trade that goes "nowhere" is just that much more likely to hit your stop loss. Don't wait for it - just get out.

2) There is a great quote in "Market Wizards" where Soroes says something to the effect of "when you're right you gotta be a pig - you can't own enough". The second major point of the Phantom of the Pits is that you need to add to a winning position when you are right. You gotta punish the market when you are right because otherwise you won't achieve much beyond break-even.

I have to admit when I originally heard the concepts of cutting your losses and adding to winners I didn't get it. I use a stop loss - isn't that cutting your losers? And adding to winners sounded dangerous - if I was making money the last thing I wanted to do was let it ride. I wanted to grab those profits quickly! So if you are looking for some ideas to increase your trading edge I strongly suggest looking into these. Especially for those folks who are trend traders this can really make or break you.


Type rest of the post here

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