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Easy way to cut losses
by Malcolm Robinson
I have successfully given up two unhelpful behaviours, 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
anyones 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.
Difficult
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 Carrs book got me to consider whether I actually
enjoyed smoking and I discovered that I didnt 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 couldnt give up.
Beneficial
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 doesnt 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 doesnt have a choice; he cant 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.
Our psyches
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.
Broke
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.
Anticipating the market and execution
I divide trading skills into two distinct elements: anticipating the market and execution.
The anticipating part is reading the market, whether through charts, systems, technical
indicators or intuition. Anticipating/reading the market is the trading skill that most of us
focus all our energy on, and it is the subject covered by most trading books and seminars.
The execution part, meaning the actual trading part, is an often overlooked skill of
trading. A good way to clarify the distinction between being able to anticipate the market
and being able to effectively execute the trades is to describe the difference between the
brokers and the locals on the floor of the exchange. (In Europe the floor no longer exists
as all trading is now electronic).
Locals on the floor are independent traders trading for their own account (profit). Their
motivation is (like ours) to make money and their preoccupation is (like ours) to be able
to anticipate the market. The job of brokers on the floor is to execute orders from traders
not on the floor. These orders may be from bank traders trading in an office or
independent traders trading from home.
Ruthlessly efficient
Either way these orders are generated from somewhere off the floor and they need to be
executed on the floor by a broker. So what makes a good broker? Think about what you
would want from a broker. You would want someone who executes your trades with the
utmost efficiency i.e, no hesitating, no indecisiveness, no coyness.
A broker needs to be sharp and alert to what is happening in the market so that they are
always in a position to immediately execute any trade that they are given. A good floor
broker is a joy to watch, they are ruthlessly efficient. They can go from idly chatting in a
quiet market, to disseminating an endless flow of orders in a busy one.
Now imagine having to trade through a broker. What would it be like trading through a
novice broker? Someone who doesn't know one end of an order from another. Not a
pleasant prospect! Now imagine what it would be like trading with a highly skilled and
experienced broker... Quite a different experience I think you will agree.
Anticipation and execution
Locals have to both anticipate the market and execute their own trades. If you think of all
the possible combinations:
Good anticipation / poor execution,
Poor anticipation / poor execution,
Good anticipation / good execution,
Poor anticipation / good execution,
It is obvious which we would all rather be, good / good; but which combination would
you say you are? I suspect there are a lot of good anticipation/poor execution traders out
there who lose money despite their anticipation skills. So not only do we need good
anticipation skills we also need good execution skills to succeed in trading. We need to
develop the attitude of a broker when it comes to the task of actually executing our
trades.
A broker is judged by his execution skills. It does not matter to a broker whether the trade
he has just executed for a client is profitable or not. The broker, his boss and his client are
only concerned with his ability to execute the trade efficiently.
So a broker gets to fulfill his need to be successful, to be a winner, by doing his job
efficiently and effectively. That is all we can ask of a broker, it would be crazy to hold
him responsible for the outcome of the trade. Going back to my earlier analogy of the
trading floor, a local trader, on the other hand, is responsible for the outcome of his
trades.
The local is trying to make money by anticipating the market. So a local has to decide
whether it is a good time to buy or sell and then execute the trade. He is doing two things,
deciding when to trade and then executing the trade. A local therefore has two aspects of
his trading to judge, the accuracy of his market anticipation and the execution of his
trades.
Poor execution or anticipation?
We know that trading is a numbers game, i.e. our success is not dependent on the
outcome of the next trade; our success is dependent on the overall profitability of many
trades. So while we are trading, whether the last trade we did was profitable or not is not
important; there is no point drawing conclusions on the outcome of just one, or even a
few trades.
We can only access our anticipation skills when we have made a reasonable number of
trades and we can see the longer-term result of our actions. This contemplation is best
made when we are not trading, when that markets are closed or when we are taking a
break. When the markets are open and we are engaged in trading, the only thing it is
appropriate to judge is our execution skill.
When we are trading our goal should be to focus on executing our trades with ruthless
efficiency and to judge only that. If you consider the ways that you lose money trading, I
think you will find that it is down to poor execution, rather than poor anticipation.
Appraise and amend
You fail to place a stop loss according to your predetermined loss limits,
You place a stop loss but then move it as the market approaches,
You hesitate and miss an opportunity that you had clearly seen,
You trade out of frustration or anger,
You fail to use a trailing stop to protect your profit,
You let a winning trade turn into a losing trade etc
All the above (and there are more) fall into the category of poor execution rather than
poor market anticipation. So if you want to turn your trading round, or make it more
profitable, then cut out the above mistakes by focusing all your energy on executing your
trades. Only judge yourself, when trading, on your execution. You can appraise and
amend your strategy/approach when the markets are closed.
If You Wool Like To Learn More About Malcolm's Fantastic Course
http://www.wizardoftrading.com/go/tmot.html
Good Trading
Best Regards
Mark McRae
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