The popular adage to success in the markets is: Cut your losses short, and let your winners run.
Though in theory it may seem simple, for most of those in the trading arena, it is rather difficult. And that's why we have that statistic that 95% (or was it 97%) of traders are net losers over the long term. So the question must be asked; Why?
William Gallacher, in his book "Winner take all" says its very easy to spot traders that lose, simply take a look at their open and closed trades. Most of the open trades are losses, some of them substantial, and the closed trades are always positive. Usually small in magnitude.
So from this it can be said that most traders do exactly opposite to what is required to be successful, they take quick, small profits, and never take losses.
Why do they trade this way? Because of their ego. Taking a loss is like admitting you were wrong. Some people, and I don't mean Average Joe's here, I mean professional money managers, think that a loss is not a loss until you sell.
That's why I think fundamental analysis is so dangerous. Because of the hours spent analysing the company and its prospects, you are more likely to hold onto a loser for longer than you should, rather than somebody who looked at a chart for a few seconds or bought the stock because it triggered an entry on the system.
I was having a conversation with my dad the other day and I asked him if he thought anybody has held PDN all the way, and he said probably not. Yet there are a few that I know personally that are still holding the script of dot.com stock, bought for a few dollars, and now if the company is not delisted then its worth a few cents at best.
Those that constantly lose either:
1. Don't have a well-tested robust trading system which allows them to cut their losses and let their winners run.
2. Have a trading system but do not have the discipline to stick to the rules or understand that every system inevitably will experience periods of drawdown.
So it seems it is human nature so trade EXACTLY opposite of what is required to win.
The only thing I can think of which is worse than letting your losses run is adding to losing positions. If you just think about what this will achieve, by the end of it, you will have many shares of a dog. If you pyramid as the share price goes up, there's a good chance what you'll end up with is many shares of an absolute champion.
The reason why profits seem to be taken quickly by those who lose is that they take the view that you better lock in a profit while its there. Problem with that thinking is that you will never have any big winners.
It's not hard to be in the 3-5% of those that win. As William Eckhardt said:
"Anyone with average intelligence can learn to trade. This is not rocket science".
I'll end this post with a few quotes from Michael Covel's "Trend Following".
Referring to $8.4million in WorldCom stock now only worth about $492,000: "Until you actually sell it, you haven't lost it" - Robert Leggett, Kentucky Retirement Systems.
"If you had Enron in your portfolio and didn't sell it at $90 or even at $10, don't feel embarrassed. On the surface it had always seemed to be a fairly good growth stock. We bought it all the way down" - Alfred Harrison, money manager at Alliance Capital Management Holding LP.
(The above 2 are professional money managers, these guys actually get paid to manage other people's money).
Enron stock was rated as "Can't miss" until it became clear that the company was in desperate trouble, at which point analysts lowered the rating to "sure thing". Only when Enron went completely under did a few bold analysts demote its stock to the lowest possible Wall Street analyst rating, "Hot Buy".
(Gotta love analysts).
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