Tuesday, June 03, 2014

Three of those and one of them is four

The title of this post is a famous quote from the US golfer Walter Hagen.  He was the undisputing king of matchplay golf in the 1920's, winning the USPGA Championship (which in those days was a matchplay event) five times. He would infuriate his opponents by zig-zagging his way from tee to green, before a miracle shot out of trouble, or a holed putt, would halve or win him the hole.

I often wonder if some traders think in the same way of trend followers. Historically, a win rate below 50% (and often below 40%) would be sufficient for a trend follower to make reasonable profits. We may lose on three trades, but then strike a winner on the fourth trade - may be even a big one. This must be frustrating for those traders who seek a very high win percentage.

To carry on the Hagen analogy, after not having any positions open for a couple of weeks, in the last few days I have opened four new trades. Of these, three have quickly failed - the rationale for entering was invalidated, and I cut my losses and exited. The other trade, however, is showing signs of developing into a decent trend. While not being an explosive move, it has been sure and steady. As a result, that one open trade has covered the other small losses and left some profit over.

This is how I prefer to trade. I am brutal with the cutting of my losses. If the trade doesn't work almost immediately (and that is measured by price - what else?) then I get the hell out and move on. I am primarily concerned with keeping losses as small as possible.

Now, of course there is a chance that, had I kept those losing trades open, they may have moved back in the direction I was trading. But I would rather take the guarantee of a small loss, rather than hope that the loss can be eliminated. By doing that, you also bring into play the chance of those small losses turning into bigger losses. As Paul Tudor Jones says: "Play great defence".

By the same token, I am sure as hell not going to cut my profits short on the one trade that is moving in the right direction. No, I will let that run until my stop is hit. As it is, barring any gaps through my updated stop level, I have already reduced my open risk on the trade.

Psychologically, whenever I open a new position, I mentally write off the equity risked as being lost. Chances are I won't lose the full 1R on each trade, due to my stop methodology, but that is what I do in my own mind. If you can do that, then this can be another way you can avoid risking too much of your equity on any one trade.

It is important to remember that your first loss is your best loss. Losses are a cost of business. You've lost on a trade. Big deal - log it and move on. You are one trade closer to finding a winner - may be a big one.

It's not rocket science, and is very simple. But the reality is that most individual traders do not want to accept they are wrong on a trade - they like to be proven right. Me, I'd rather make money.

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