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Nice response. I do have daily loss limits in my own plan and for the reasons you state above, but was having trouble putting together the actual reasoning behind it. For me it's always been about being able to trade another day.
In general I would not stop trading at a daily loss limit because "cherry picking" trades tends to have poor results. If you have something that works and several trades in a row have not worked out then the subsequent trades likely will balance out earlier results. This assumes of course you have a proven reliable approach to trading. That said, there occasionally are days when the market does not behave as rationally as normal (the market's version of rational, not mine). This occurs maybe a dozen times in a year (by my reckoning, many may see it differently) and those days I lower the size I trade or decide to walk away for the day and try again tomorrow. I agree that trading around P&L is a poor means for considering the next trade - I want to consistently follow proven trade rules.
Obviously this is a topic for those who Daytrade ... it does not have much application to a longer term investor as his/her vision for the trade has a longer time frame and daily fluctuations are basically meaningless.
But I will comment on limits of losses and winnings.
When I was younger and occasionally went to a casino for entertainment (BlackJack was my game) my father gave me some good advice.
He said take out the money that you are prepared to lose and place it on the table (in chips of course). Then every time you make money over that self-assigned table limit, slip the extra into your pocket.
The moment that you have exhausted your "table money" then you get up and cash out the chips in your pocket. You might have only enough to buy a hamburger or you might have had a great streak of luck and had a pocket full of chips.
By using such a strategy you give yourself a chance to leave the table a winner while limiting your losses if you are not lucky.
this works well....there is such a thing as riding a streak of luck and if you limit your profits you will never find the extent of that lucky streak
The purpose of establishing daily loss limits are 2 fold:
1. It ensures the conditions for the strategy are valid and adhered too. E.g, assuming one is trading an intraday breakout method for a trend day and and the initial trade fails and stop outs. The trader decides that it might be a retracement and re-enter should price reach the same level again. Price hits the same level again and fails. By now it should be quite clear that the trend day is no longer valid and perhaps setting up for a ranging day. But if there are no established rules on the number of trades, there is no way to test the validity that the breakout day has not materialized and the trader continues to trade in a random fashion getting whipsawed.
2. It ensures losses are kept low. If the trend day does not materialize, it may occur perhaps the day tomorrow, or the week after. However, the whipsawed trader from the earlier example has loss too much with no control of his number of trades or position sizing. What could have been a loss of 5% would require a 5.26% trend day return. However if the loss was 50% it would require a 100% trend day return to recoup the losses. This is the asymmetry of returns.
Even for longer term trading, the losses are worked out first on the onset to limit the total portfolio exposure at any point and ensure sufficient margin to equity ratios. Otherwise, similar to the daytrader but on a larger time frame, a bad month would take much longer to crawl out from drawdowns.
I would agree that both are good. In my experience I've seen winners turn into losers and losers turn into even bigger losers. so a stop on either side is helpful.
I have never seen anyone say that you should only have daily loss limits while day trading but that you shouldn't have one for longer term traders or investors.
I do like the blackjack story though. I do something similar when I play in Vegas.
You could if you had a prolonged string of losses on anything and be out of the game....however, as a long term trader myself, if I have chosen the stock properly, I would not have chosen a risky stock that is going to wallpaper in a hurry so losing up to 10 % on a given stock, while cause for concern, it is not necessary to bail out completely... After all it goes against the reason you bought the stock in the first place.
Such small losses though for a day trader are critical as they don't generally give a lot of thought to the long term viability of a stock...they are more interested in a 2-10% flip in a day...that can happen to any stock on any given day.
{Shrug} you have lost nothing in a paper loss until it is sold...then it becomes a real loss.
A series of losses to a long term trader may or may not be of a concern. There can be many reasons for these loses and may in fact be a reason to buy on the dip. One does not ignore such paper losses and would cause the long term investor to judge if there was a fundamental reason for the continued losses but in many cases the loss of 5% could be simply profit taking or an uncertainty in the general market or sector. This IMHO would be a mistake to sell on the first couple of days of losses...I cannot count the number of times I have in the past panicked and sold a stock only to see it rise a day or so later.
Every investor has their own tolerance for risk....If you look at my fantasy portfolio in my journal here, you will see severe losses in 2 of the 8 or so stocks...am I in the red since starting in Feb??....no...in fact I am still up over 2% from what I started with....yes I could have been up more if I had sold those stocks when they first started to fall...but I am not that psychic to catch stock then...PLUS...the fact that from my analysis I still like these stocks long term. Unless I find a lot better place for the money and right now I don't see one...I will continue to hold these stocks and when they turn around as I fully expect them to do they will be contributors to my bottom line in the portfolio.
Let me ask you this then....in your trading experience...what is the maximum time that you have EVER held one stock??
Me? In real life I have a few stocks that I have held 1-3 years... and made money on most of them. My average hold on a stock is 3-4 months....You only have to look at the journal I keep here to see that I walk that talk.
there is a different mindset between a long term trader versus a short term trader.
BTW...yeah it is a nice story and a good practice if you like to gamble.
What most attribute to as a "lucky steak" or "Bad luck" is nothing but a sequence of statistical outcome when it comes to a game that is purely numbers. There is no luck, and when you apply a statistically large sample (in your case blackjack) like 100K hands, you would see that "luck" and "bad luck" tend to disappear.
Its the same thing in trading, you can trade a bad strategy, yet have winning outcomes.
This will not hold in the long run because you are increasing your sample size (number of trades you are doing).
The opposite could exist as well, you have an excellent strategy, yet have loses upon losses.
This is when most stop, go back to rewriting things and potentially "kill" something that was good.
Matt
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