Letting Your Winners Run, Cutting Your Losses Quickly

Wall Street has many great sayings. One that I try to live by is “let your winners run and sell your losers quickly.” Many people buy into the “letting your winners run” part, because they have also bought in to Wall Street’s buy and hold philosophy. However, unless you are planning on “letting your winners run” until retirement – you will need to sell at some point. So when do you sell. In particularly, when do you sell a winner? Let’s take a closer look.

If you really think about it - you have two options for selling a stock: selling as it is rising (into strength) or selling as it falling (into weakness). To accomplish yet another famous Wall Street saying, buy low and sell high, by definition - one must sell into strength.

Selling into strength is a proactive trading strategy. It requires selling when a stock is still rising but is expected to reverse. The problem is trying to determine if a stock is preparing to reverse or if it is simply pausing on its way higher. This is a critical decision point.

I believe that if your desire is to let your winners run – the stock must be given the benefit of the doubt until it proves that it is no longer rising. Thus, letting you winners run and selling into strength are mutually exclusive. In other words, selling into weakness is a consequence of letting your winners run.

Some of my subscribers were disappointed a few weeks ago when we watched as a great deal of our profits in DBA slipped away. That is simply a result of the philosophy. I have accepted that with this style - I will not sell at the highest point.

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Although I sell my winners slowly – I sell my losers quickly. Stocks often forget which way is up. Usually, the first day is no big deal. On the second or third day, most will start getting a little edgy. By the fourth day, this joke is no longer funny. If something unforeseen happens and stock is whacked hard – panic sets in.

In the above scenario, anxiety increases each day as the stock declines. Anyone that has placed more than a couple of trades has faced this emotional battle. Experienced investors understand that controlling their emotions is critical to their success. Cutting losses quickly prevents emotions from clouding your judgment.

The math of large losses also works against a losing position. A stock that falls 20% requires a 25% gain to break-even, not 20% as many think (20 * .8 = 16; 16 * 1.25 = 20). A 30% drop requires 33% gain. A 40% loss requires a 50% gain. It is amazing how many people hold on to a losers praying that it will go back up.

The Holy Grail of trading is buying at the bottom and selling at the top. I am comfortable carving out profits from the middle – by letting my winners run and cutting my losses quickly.

Comments

[User 171220:]

I agree that it's very hard to pick a top or bottom, so selling somewhere in the middle makes sense.

2008 Apr 01 02:13 PM

[User 171220:]

I agree that it's impossible to predict a top or bottom, so selling somewhere in the middle makes sense. Sometimes being greedy and waiting for a stock to hit a top before selling results in losses as the stock may move quickly down.

2008 Apr 01 02:13 PM

[snaveran:]

Why not sell incrementally? That is, take some portion of profits of the table. Everytime the stock rises 6%, sell 6% of your shares. 10% rise, sell 10%. 25% / 25%? It's like giving yourself a dividend. This buffers against not getting out in time and possibly incurring a loss. If at a profit, you're just incurring some extra commission which are typically cheap these days, so why not a few extra trades? The extra money is available to be put to work on another investment. Essentially, you're selling into strength, as the author puts it, just not all of your position.

2008 Apr 01 04:14 PM

[jimmy46:]

buy low sell high, brilliant idea, thanks

2008 Apr 01 05:26 PM

[chistletoe:]

What I happened to pay (or receive) in order to achieve some position, be it long or short, is not and should not be any part of any decision as to whether to buy, sell, or hold what I have. What is important is,
do I think the current price is less than, equal to, or greater than the way the market is currently pricing it.

2008 Apr 01 02:13 PM