Cutting Your Losses- what does it really mean?

Anybody would want to cut their losses, so surely there must be something more to this well worn advice than meets the eye?

There is. One of the principles of successful systems trading is run your winners and cut your losers.

This is more than just casual advice - the successful traders set up their systems to exploit profitable opportunities and avoid situations that threaten to cause losses.

Systems traders expect to get a significantly higher proportion of losing trades than winning ones but they rely on a smaller number of bigger winners to overwhelm a larger number of smaller losers.

By testing their systems using special methods, they give themselves the best chances of achieving success.

One of the first and most important things a trader does with any system he evaluates is to establish the maximum risk he is prepared to take on any trade. This is partly determined by his own attitude to risk and partly by the characteristics of the system (its risk resonance).

When he knows how to calculate the maximum risk he will take, this can be used to fix the exit point for any trade that exceeds this level. It is used to set up what is known as a protective stop.

The protective stop is there to see that excessive losses are avoided wherever possible.

 

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