Losers Average Losers — Risk Management

‘Losers average losers’ is a popular Wall Street saying. So is ‘cut your losses short and let your winners run’. They’re both true, at least in my experience. Shortly before the recent market bloodbath, I’d incorporated strict controls by exiting trades at a 10 percent loss. Yes, the exits piled up recently, but it saved my ass. Now if I could find some winners to let run. God knows when that will be.

I decided on the 10 percent level after reading Trade Like a Stock Market Wizard: How to Achieve Super Performance in Stocks in Any Market:

“I decided to adjust all of my past losses to an arbitrary level of 10 percent to see what the effect of capping the downside would be. This included adjusting the losses that were smaller up to 10 percent as well as adjusting the ones that were larger down. As I said, occasionally I would hold on to a stock that had fallen, and from time to time I would take 20 percent and even 30 percent losses. When I adjusted those losses and capped them at 10 percent, the effect on my performance was amazing. Capping the losses would have knocked me out of a few of my winners; however, this consequence was overwhelmed by the loss-cutting effect. The hypothetical improvement in the overall portfolio performance seemed too dramatic to be believed. I rechecked the math two or three times, and the numbers were correct. Instead of having a double-digit percentage loss in my portfolio, I would have had a gain of more than 70 percent.”

Yes it is that Mark Minervini, the one who went viral on CNBC. But let’s not throw out the baby with the bath water.