There’s a couple of trading sayings out there that just drive me nuts. Most of them aren’t really true, but they sound really damn good. Like, “don’t worry about your winners. Your winners will always take care of themselves.” Well, that’s not the case. What happens when people start making money? In my experience, that’s when they start to freak out. Taking winners is oftentimes one of the hardest trades out there. If you don’t have a set bunch of rules that you follow, so we’ve gone over this a thousand times. You could trail with structure, you could trail with a percent stop. It’s really up to you. Some folks like to lighten their load as the thing moves up in their favor.
But the one that I’m talking about today that I think is even more important because your gains will only look like gains to the extent that you keep your losses small, is that “your first loss is your best loss.”
If you like me, were starting out pouring hours and hours into charts and trying to figure out where’s the best entry, what’s the best name? You’ve got limited capital. So there’s a huge amount of opportunity cost, right? If you’re putting on a certain trade and then you put the trade on and it starts working against you almost right away, and you’re standing there looking at the chart in real time in disbelief, what the hell’s going on here? And one of the ways that I improved my trading very, very greatly when I first started was to keep my losses small. As you remember, stocks were trading in eighths and the commissions were much, much higher. So I had to be very, very proactive. I could not sit in losing trades, and I stole a rule from a Greenberg who was the head of prop trading and the chairman of Bear Stearns, which were really, really good prop trading, a prop trading firm back in the day.
And no matter what happened, he would say, whether it’s it’s General Electric, it could be the bluest of all blue chip stocks. If the position is down coming into Friday’s close, we trade it away. We never take losers home over the weekend. And so I started to think about that. Well, maybe I can anticipate my losers a little bit better, which kind of sounds weird. I have expertise in tax loss carry forwards, and so what I did was if I had a 1% stop say on my equity, I would never wait. If the trade was down like a half a percent to say three quarters of a percent, I wouldn’t wait for it to keep leaking until the stop finally got hit. If it started to show me a loss right away, I’d puke it out of the portfolio. My experience was that if I got the momentum right and the timing right, because right, you have good luck and bad luck, good timing, bad timing. As long as I could get the trade on at the right price and I would have the momentum win in my back, the thing would start making me money. But every once in a while, you just get one wrong and it sucks, but I didn’t have time to do. What happens when it happens? You get blasted, then you’re looking at the screen and you’re like, man, is this thing going to come back?
And now it’s sucking up all your mental energy. You can’t do anything else. You can’t think straight. You’re kind of frozen in disbelief. And this especially happens if you’re in a position and you’ve taken it home overnight and it’s acted sharply against you at the open, it could really stun you into not taking really good actions. So while I don’t really follow a lot of these trading sayings, because you have to live them to see if they actually make sense for you, that’s not a one size fits all. The one thing that I can say that’s absolutely true that will help you improve your trading performance overall and help you keep your losses smaller, is to understand that the first loss you take on a trade will be the best one if you sit and wait in it, and a 1R becomes a 2R becomes a 3R. Now you’re into hoping and wishing and waiting, and it’s a quick way to vaporize all your cash.