It’s hard to follow the advice in ‘cut your losers, let your winners run’.
And that’s because the advice relates mainly to investment psychology. Fear
are the main culprits at work here, explains Gareth Stokes, in Fear, Greed and the Stock Market
Firstly, think about the words “cut your losers”. Is this not a simple enough suggestion?
Well at first glance you’d say yes. But imagine a real world situation…
Greed makes it hard to cut your losers
You’ve spent ages studying a company that you really like. You’ve finally got the courage to buy the share.
You decide to invest a big portion of your available funds in this share...
Two weeks later, you check the prices and notice the share is down 18%.
You want to be a disciplined
trader. You know you’ve got a 15% stop loss
strategy in place.
But, for some reason you can’t bear the thought of cutting the share. You’re so sure it will bounce back!
And in your certainty you hold the share. You break the trader’s axiom ‘cut your losers, let your winners run’ by holding on to one of your losers.
Just as greed inhibits your abilities to cut your losses, fear impacts on your ability to let your winners run!
Fear stops you letting your winners run
For example, imagine your research has paid off…
You’re sitting pretty in a position where your share is up by around 50%.
The doubts begin to grow and you start to fear your initial analysis is wrong. You worry the share will fall again – and your gains be obliterated.
Try as you might you can’t fight it and you decide to sell the share. Two weeks later you’ll be ranting and raving as the share goes up another 50%.
You’ve missed the opportunity to let your winner run!
It takes plenty of discipline to adhere to this principle, but if you can you’ll be a more successful investor.