‘Cut Your Losers’ is a natural follow-up to my previous ‘trading lore’ article. Here we have another cliché, frequently used in the game of trading and investing.
Many misconstrue this piece of ‘trading wisdom’ – but it is very powerful if used correctly.
People take this phrase to mean: get out of a trade as soon as it starts to draw down. This could not be more misguided.
You have a reason for entering a trade, a stop where you are wrong on the idea and stats to back it up. Why would you get out at the first sign of being offside?
I believe the answer is two-fold.
You may think entry precision is the be-all and end-all to trading (it isn’t) and you can’t bear to see your trade underwater. That is one issue. Maybe you simply don’t have enough stats on trades and MAE to have the balls to hold a trade.
Getting out of trades at the first sign of being offside, you will likely miss out on a lot of opportunities.
The chart above shows a long trade idea. Many would get out of if they took ‘cut your losers’ in it’s most rudimentary meaning.
You are long the market in what you believe to be a high probability area. Your stop is in a place you’re happy with, you know the odds.
It may be the case that you even know the stats for your stop being hit.
Would you ‘cut your loser’?
Collecting stats on trades is simple when you have a good sample of exactly the same trade setup. (50 trades at absolute minimum but 100+ for increased accuracy).
You can trade with more confidence when you know what’s expected from your trades.
The wrong way to ‘cut your losers’, is to get out at the first sign of being underwater.
What about using it to your advantage?
When going through your losing trades, you may find a specific pattern allowing you to exit losing trades early. You must make sure that this pattern doesn’t keep you out of winners. Make sure to track the effects if it does.
You’ve now reduced your average loss to -0.5R (half of your initial trade risk). That is incredible. Just through finding patterns in losers you can halve your average loss.
As we discussed in a previous article, you don’t need to shoot for 3R trades all the time, especially if your average loser is only -0.5R.
Even if your average winner is only 0.8R, by virtue of your smaller losers, you still have a great average payoff (0.8/0.5 = 1.6R).
With just 50% winners you still have a good positive expectancy.
There will be more on how to journal and how to use these stats to your advantage in the future. Don’t forget to sign up for notifications via the form on the right of the page!
These are my thoughts on one trading cliché which is often applied very poorly. Take it with thought of what it really means. See what it can do for your bottom line.