"Cut your losses short and let your profits run"

[markd01]

Does the rule of thumb "Cut your losses short and let your profits run" apply to mean reversion short term trading systems?

I would argue that it makes sense in momentum or trending based systems, but not necessarily in mean reversion systems.

My mean reversion trading system has these exit rules:
1) exit at profit target (exit early with nice profit)
2) or exit no matter what (at loss or profit) in x days (so if there is a loss in the first day or two, I don't panic and still wait for mean reversion to occur, as opposed to cutting my losses)
3) only cut your losses early if the loss is caused by some significant unexpected news (ex. biotech co. FDA decision, defense stock gets a substantial military contract, etc) that justifies continued momentum

 

[brokenmarkets]

if your position is 90% margin and trading ,yes cut your losses and run.

mutual funds investor have the luxury to buy and hold. and they die with their investments cause they lose at least 50% just by exiting their large positions.. and 100% tax loss.

buy and hold investors can't leave when the walls are crumbling stuck with their investments. mutual funds with large positions can't exit like small traders can..in the open market with a market order.

Quote from markd01:

Does the rule of thumb "Cut your losses short and let your profits run" apply to mean reversion short term trading systems?

I would argue that it makes sense in momentum or trending based systems, but not necessarily in mean reversion systems.

My mean reversion trading system has these exit rules:
1) exit at profit target (exit early with nice profit)
2) or exit no matter what (at loss or profit) in x days (so if there is a loss in the first day or two, I don't panic and still wait for mean reversion to occur, as opposed to cutting my losses)
3) only cut your losses early if the loss is caused by some significant unexpected news (ex. biotech co. FDA decision, defense stock gets a substantial military contract, etc) that justifies continued momentum

 

[Zr1Trader]

So whats better?

1. Having an average risk reward of 3 to 1 and having a higher win rate

2. 10 to 1 with a lower win rate

3. trailing every stop at each new higher low as the market moves in your favor (letting the winner run)

4. taking an initial position of say three contracts, having two targets and letting the last contract be the runner?

 

[goodgoing]

Quote from markd01:

Does the rule of thumb "Cut your losses short and let your profits run" apply to mean reversion short term trading systems?

It applies to everything. It is a general statement, like a principle. It does not tell you by how much to cut.

 

[chartman]

Quote from markd01:

"Cut your losses short and let your profits run"

This "rule" works like clockwork. It never fails. The insiders live by it. This is how they sell their long 'investment' accounts on the way up and sell short at the top in their trading account for a hedge on the way down. At the bottom they reload their investment accounts as investors cut their 'losses' the insiders are preparing for the upward trend as the investors sell their shares. Investors will not be a competition to the insiders as they hold their shares to let the profits run while insiders are selling their investment accounts on the way up again and going short on the blow-off at the top. The primary reason insiders are 100% profitable while 90% of investors are losers.

 

[dwpeters]

Quote from markd01:

Does the rule of thumb "Cut your losses short and let your profits run" apply to mean reversion short term trading systems?

Not necessarily.

http://epchan.blogspot.com/2009/06/my-interview-stop-loss-and-principle-of.html

... suppose we now have a stock model based on mean-reversion, and we entered into a long position based on a recent drop in price. A few minutes later, the price went down further instead of up, again causing a big loss on our position. If we now ran this mean-reversion model again, it would definitely tell us to buy the stock again because of the ever cheaper price. The model would not ask you to exit this position and take a loss. Hence, adhering to the model and the Principle of Latest Information will not lead to a stop loss for a mean-reverting model.

http://www.tradingmarkets.com/stocks/commentary/best-of-the-battle-plan-stops-hurt-951402.html

A number of years ago, I published a research study entitled "Stops Hurt". I know many if not all of you are aware of this study which basically showed that stops lowered the performance of most mean reversion strategies no matter how far away the stop was placed.

In fact, stops placed as far away as 50% hurt the performance of most mean reversion strategies. As I've stated a number of times, smaller position sizing and/or options are better protection vehicles than using stops and the data backs this up. Stops do nothing to protect you from overnight risk and they also tend to stop traders out before reversals occur, therefore accumulating losses upon losses.

 

[markd01]

Thank you for the replies.

For those advocating "Cut your losses short and let your profits run" and trading short term mean reversion strategies, would you be willing to share your exit rules like I have?

 

[bone]

When you enter a trade, you must have both profit target and stop/loss level determined.

For your stop/loss trigger, get out of your entire position at once.

For your profit target, scale out of your position using a trailing stop once that original target level has been achieved.

 

[markd01]

dwpeters,

You hit the nail on the head with your quotes! I have read both Enrie Chan and Larry Connor's books, and they had large impact on my strategy development.

Most people focus on their entries with strategy development, but I also wanted to zoom in on my exits, and realized that I was not following "Cut your losses short and let your profits run" rule, in its strict sense. Would you be willing to share what your exit rules for your mean reversion strategies are, at least in general sense, like I have?

My first two exit rules are mechanical, while the last rule is more subjective and discretionary. Rule #3 is actually based on Ernie Chan's Quantitative Trading book, where he refers to exiting early if momentum regime and more losses would be expected. Do you use anything like that?

"My mean reversion trading system has these exit rules:
1) exit at profit target (exit early with nice profit)
2) or exit no matter what (at loss or profit) in x days (so if there is a loss in the first day or two, I don't panic and still wait for mean reversion to occur, as opposed to cutting my losses)
3) only cut your losses early if the loss is caused by some significant unexpected news (ex. biotech co. FDA decision, defense stock gets a substantial military contract, etc) that justifies continued momentum"

 

[Ghost of Cutten]

Quote from markd01:

Does the rule of thumb "Cut your losses short and let your profits run" apply to mean reversion short term trading systems?

I would argue that it makes sense in momentum or trending based systems, but not necessarily in mean reversion systems.

My mean reversion trading system has these exit rules:
1) exit at profit target (exit early with nice profit)
2) or exit no matter what (at loss or profit) in x days (so if there is a loss in the first day or two, I don't panic and still wait for mean reversion to occur, as opposed to cutting my losses)
3) only cut your losses early if the loss is caused by some significant unexpected news (ex. biotech co. FDA decision, defense stock gets a substantial military contract, etc) that justifies continued momentum

No. Like most rules of thumb, it's a piece of lazy half-assed BS.

Part of learning a field, is getting enough knowledge to be able to analyse and assess 'received wisdom' on its true merits, and then realising that some of it is total bullshit, and some is only true in certain situations and outright wrong for others. You then form your own rules based on personal observation, experience, results, and your own thinking. These kind of pat 'trader rules' are usually only applicable to some situations, they are not universals. There are a few universals, such as never take a risk that could blow you up, and always prepare thoroughly, but they are a different category of advice.

With most mean-reversion, you should hold on if it moves further against you, and maybe add more (within limits). Obviously you need some risk control for the rare trades that keep on going, so you need to either hedge with options, trade small, or have an ultimate "disaster stop". But your stop should be far away, because any close stop will likely get triggered just as the move is about to reverse dramatically.

The problem is that people who are crap at trading, get in too early on mean reversion trades, then average in too aggressively, and end up with huge positions that they puke out of or go bust with once the panic buying or selling hits. Mean reversion is particularly brutal at punishing trading mistakes, whereas momentum trading is more forgiving. That is why holding or adding to losers has a bad reputation, not because the technique is intrinsically bad in all situations.