Easy Way to Cut Losses
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Finance > Investing
Apr 18, 2007
Easy Way to Cut Losses
I have successfully given up two unhelpful behaviors, one was smoking which I stopped 10 years ago; and the other was drinking alcohol, which I gave up last year. Most people these days agree that smoking is a bad habit, but equally most people still consider drinking to be perfectly healthy in moderation. I no longer have that opinion about alcohol, but I have no interest in attempting to change anyone's view about either drinking or smoking. I bring this subject up because I think there are parallels to trading. If we go back to basics we know that to be successful trading we need to cut our losses and let our profits run. I think everyone agrees on this, it is stated in virtually every trading book ever written. The fact of the matter is though, that we all seem to be hard wired to do exactly the opposite. If you look at your trading results over any period of loss, you will see that your losses come from trades that you did not cut. It is unlikely that your losses are attributable to a large number of small losses, far more likely that they came from a few large losing trades, i.e. trades that you did not cut. If this is the case for you, then success in trading will not depend on you finding the right trading system or idea, it will depend on your ability to learn to ruthlessly cut your losses. The question is why is it so difficult? I smoked from the age of about 12 until I was 25. During that time I made many attempts to quit, like most smokers, but it was far too difficult, so I never succeeded. That was until I read a book called "The Easy Way to Stop Smoking" by Allen Carr. Allen Carr's book got me to consider whether I actually enjoyed smoking and I discovered that I didn't at all. Once I made this discovery I stopped smoking, I stopped smoking and have never had the desire to smoke again. It really was easy. The reason that I had found it so hard to quit before, was because I was under the illusion that I enjoyed smoking and that there were benefits to be had from smoking. So even though I was also aware of all the negatives of smoking I couldn't give up. Yes, because I was giving up something that I loved doing (or so I thought). What has this got to do with trading? Well what I have learnt from my experiences of giving up smoking and drinking is that I only do things that I am motivated to do, i.e. I only do something because I think there is a benefit to me in doing it. As soon as I realise that there is in fact no benefit whatsoever, I stop, without a single thought. I found this to be the case with both smoking and drinking, when I realised that the benefits I thought I was receiving were in fact illusory, I just stopped having any desire to drink or smoke. With trading I realise that when a trader finds that he repeatedly lets his losses run, he cuts his profits short, it is because (perhaps on an unconscious level) he believes that it is beneficial for him to do so. So what possible benefits can a trader think he will receive by not cutting losses? I think this question cuts to the very core of the difficulty of achieving consistent trading success. When we offer advice, in any situation, we are making one big assumption: that the person we are advising has a choice. So if I say to a losing trader: "Cut your losses when they are still small", I am assuming that he has a choice and that up to now he has been making the wrong choice. He simply has to take the option to cut his losses early and hey presto... Now of course this is excellent advice and would stem the bleeding; but it is useless. It is useless because the trader doesn't have a choice. He is not letting his losses run because he chooses to, if that was the case his problems would be solved the first time he read about cutting losses. It must be that the trader doesn't have a choice; he can't help himself! But why? I think the answer lies in our upbringing and, more specifically, what we were taught and what we learnt about success. Whether in business or in the sports arena, we are taught to be persistent, to persevere against the odds. We are taught to be steadfast and not a quitter. We are taught to be decisive and not fickle. We are taught to conquer and overcome problems through our decisiveness and the application of our intelligence. And perhaps the overriding rule of life we are taught is to be a winner and not a loser; our aim in every endeavour is to win not lose, it is hard wired into our psyches from an early age. So how does this attitude to success stand with trading? With this attitude we come to the market with the desire to conquer it with our all-powerful intelligence. Why else would we spend hours studying charts and testing systems, trying to find the key that no one else has found? With this attitude we attempt to overcome the market through our steely determination, how many times have we heard of the gold digger who quit an inch from a rich vein? With this attitude we are determined to persist until the market submits its treasure to our greater powers. Why else do so many traders go broke before they quit? And cutting losses well, cutting losses is akin to fleeing at the first sign of trouble; it is weak, fickle and dishonourable. No wonder we hold on for dear life! Everyone wants to make money, that's a given and that inevitably leads us to look for ways to take money out of the market. The strange thing is, though, that the harder we search the more inaccessible profits become. Why? I think there is a fundamental flaw in our approach. Our approach is to seek out and deploy a trading system or strategy that will ensure a steady stream of profits. That is why we all spend so much money on books, courses and seminars. We think that out there, somewhere, is the idea, the system, that will turn us into successful traders. Yet, even when we think we have found the missing link, it doesn't seem to work, we are not converted into big time, consistently profitable traders. Don't get me wrong, this does not mean that I think trading ideas and systems and strategies are useless. Far from it, they are an essential element of successful trading, for sure, but they are not the only, or even the biggest requirement for successful trading.
Martin Chandra is a full-time investor. He has been researching investment strategies and make his own living. For more information please go to here.
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