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Follow these two rules to preserve and grow capital

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josh View Post
Based on my own experience and failings, I've formally adopted two rules:

  1. Never add to a loser, EVER. EVER. If adding to a winner, close the position if the market moves to your average entry price (your breakeven point), and only add above (if long, below if short) your previous add.
  2. Don't take more than 3 losing trades in a 15 minute period, and 10 trades in a 2 hour period (adding to a winner doesn't count as a trade; a 1 tick or greater loss does count).
Rule 1 prevents death by nuclear explosion.
Rule 2 prevents death by a thousand cuts.

@josh,

There's a lot to be said for both of these rules. Just a couple of comments on each:

Rule 1: I follow this one religiously. However, I recall both Mike and Gary in the old days of the spoos thread "scaling in" -- adding to positions that were going against them because they would improve their average cost basis, and they were willing to be wrong if it came to that (they would bail quickly if they found they were wrong.) They were right often enough to make it work. I never understood how to do this, and obviously it takes deep, deep pockets -- and if you're wrong very often or very big you're in deep trouble -- but some people can do it.

I'm not one, but it's not necessarily a universal thing. (Note: "Gary" is Tigertrader, for the non-OG's. )

Rule 2: Everyone should have some loss-control rule or rules that they never let themselves violate, even at the highest point of "I've got to make it back" insanity.

I have something similar. My trading involves trend following, in part, so I am subject to whipsaws if I judge the situation wrong and the market just goes up and down in a small range. My rule is that after two whipsaws in a row, I'm done. I can go back in after an hour, but usually I just stop for the day. There's something wrong with my read of the market, and I can't rely on it now -- better to fold.

I think that everyone should have some hard rules to prevent both the "nuclear explosion" and the "thousand cuts" outcomes. Even if scaling in, a trader will have to stop the process at a certain point if the trade isn't working, so you need a way to judge that, if you don't just use "it's going against me" as the criterion.

Exactly what rules to use will depend somewhat on both a person's trading style and self-knowledge. For instance, I know that if I permit myself to scale in, I will end up at the bottom of a deep, deep well, so I simply won't.

Bob.

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