Phased Exits and Managing Losses

Q. 'Problem is that sometimes I end up with stocks that go in the 'wrong direction' for a long time as I don't like exiting with a loss...'


A: Oh dear. Yes - it does take a while to accept that losses are for taking not for nursing. But it is vital to get to the stage where zapping losses becomes a badge of honour (being the right thing to do) - not an admission of defeat. And the smaller they are the better - which usually means taking them early. Most beginners find it difficult to get there. Having invested so much belief and care into choosing a position in the first place, it don't feel right to abandon it almost immediately. It's as if doing so casts doubt on ones judgment. It takes all of us a long while to come to terms with the need to be clinical.

It doesn't even matter if losses outnumber wins - as long as they don't outweigh them.

Many traders happily operate with losses routinely outnumbering wins. Sixty losses to every forty wins is a perfectly OK ratio. If losses are taken early it is quite likely there will be lots of them showing on the ledger - but as long as they are tiny, that's fine. It doesn't even matter if the decision to take the loss subsequently looks to have been unnecessary - because being such tiny issues, they can be shrugged off ;o).

One of the biggest advantages of spreadbetting (a truly huge advantage in my view, and overlooked by many), is that there is no cost penalty in exiting a position in stages. This removes that dreaded stress-laden moment of deciding to give a position the chop - when so many traders who set an exit level find themselves 'frozen in the headlights' and reluctant to push the sell button... and end up dithering - only to see the price get worse - and then falling into 'Oh well it's too late to get out now, I might as well grit my teeth and hang on in there' mode.

Exiting a conventional holding in stages is costly - paying brokers commission on every partial trade. But with spreadbets I will quite often trim a position and trim again - and all the way out if the price continues misbehaving. There is thus no single major exit decision involved. Or you can set a phased stoploss framework - in which you might exit a third of the position on a 5% fall, another third when down 10%, and only dump the remaining third when down say 15% or 20% whatever - so you feel you have given the stock every chance before killing it.

My accounting period is the tax year. I have made more losing trades than winning trades (first time that has happened) but my win : loss ratio ratio is over 2:1. Job done. By the way, if you don't have a clue what your personal ratios are then you are not managing your money properly. You can lie to your friends, family and on board rooms but don't delude yourself. If your win : loss ratio is negative or close to 1:1 then, in my very humble opinion you are doing something wrong.

Q. 'Sitting with 170k shares at average 68p. Sold nearly everything else to add last week to bring my average down to 68p...'

Here's another classic one on a forum discussing a company which produces zero-emitting vehicles and whose share price had plummeted from the 200p levels to the lowly 30's] -:

'Sitting with 170k shares at average 68p. Sold nearly everything else to add last week to bring my average down to 68p. What a bloody disaster! Saying nowt to the wife and just hope and pray something decent happens next week.'

'Despite sitting on a 75% loss (what a I am still going to hold for now and not panic-sell.'

Me: ....the notion of panic-selling having lost 75% is lost on me! Amazing really...psychological feeling of not wanting to accept a loss and move on... he's sitting on 120k odd loss at present!

'Well in three years time if the stock is at  pound;10 then it will have been the right decision. In any case he/she has been upfront enough to admit a mistake (which of course every trader has made). Why the ridicule?'

A: It's not ridicule, it's a warning to new investors so they can hopefully learn from this. You know the magic words, keep losses small and run profits. It's the only way to stay in the game.

Well, for this company (ticker omitted on purpose) to be at  pound;10 in three years, which would capitalise it at 3.7 billion (from  pound;110m today), it will need to grow substantially faster than it did last year. I note that another in the sector has warned, that redundancy notices have been handed out and that there was no 'we know of no reason for price fall' response to the falls at the time of writing. Oh, and on a practical note, they can only produce 1000 vehicles a year right now in the US and 1500 in UK. Plans to produce 10,000 in US by 2010 and 5000 in UK 'in the future'. I note there is no specific date for UK. The order book at end of March had 523 units. The 50 mile limit (hopeless in London) taxi isn't due until mid-2009. Their biggest customer(?) has only increased its order from 50 to 150 this year. Add to that the recession   the credit crunch and a 3.7 billion cap in three years doesn't seem very likely to me.

Oh yes, and he has now got to make 200% just to get back to square one. You know the formula - lose 10% and you only need 11% to get your money back. Lose 50% and you need a 100% to get your money back, lose 75% and you need 200%. Let the price be your guide. One doesn't have to trade with nutty stops like me but 20% must be the absolute maximum, remember the old adage 'a share that's fallen 90 per cent can always fall another 90 per cent'. Oh, and with the 20% thing a good idea is to re-enter a trade once the stop as been breached to the upside. All very tricky ;)

Disclaimer: This example is purely quoted for educational purposes only and is not a recommendation to buy or sell which is the reason that the ticker symbol has been omitted.

Q. 'But if I keep holding eventually when the market turns my losing positions will become winning ones'

I thought if I hold on to shares even through this market, eventually when the market turns those losing positions will become winning ones. Maybe I'm wrong and have to change my investing style otherwise like you said I will never make money!!

A: The good stuff should recover but it could take years.

You have to understand the maths...start with 100 and lose 10%, the share has to recover 11.1% for you to get your money back. Lose 50% and it has to rise 100% and lose 72% (random number) and it has to rise 257.14% just for you just to get back to where you were. If inflation is rising at 5% a year...then after 5 years you are still some 25% (simple and I should be compounding) down. Then, there's the opportunity cost of being in cash.

Start % Lost Left Rise Recover
100 10 90 11.11% 10
100 50 50 100.00% 50
100 72 28 257.14% 72

Do you see, the maths are stacked against buy and hold in a falling market. It's not about good stuff/bad's just simple uncomplicated mathematics.

Q. 'Yes, but for a stock that has dropped from $10 to $5 isn't there a bigger chance of upside than downside?'

But can't you argument that for a stock that has dropped from $10 to $5 there is a bigger chance of upside than downside? so the odds of a downside aren't exactly the same as the upside - this assuming that nothing in the company fundamentals have changed. In the last 3 months loads of companies have lost more than 50% of their market value just because of this crisis, I can't believe the economy could have changed so much in 3 months!?

A: I have no idea what you mean. If you hold a stock from $10 down to $5 then you hae lost 50% and it has to rise from $5 to $10, 100%, for you to get your money back. It's not a discussion about odds of further downside, it's about not losing 50% in the first place.

Three months ago nobody was talking about General Motors and Chrysler going bust and Citi group was thought to be one of the survivors, now it's meeting to figure out what next and either Chrysler or GM or both may go to the wall. Nobody wants Woolworth for £1 and shareholders are biting their nails over whether Taylor Wimpey can renegotiate their debt. Interest rates have been slashed with more cuts to come. If you think things haven't changed so be it; do let me know when you think they have ;-)

Q. 'I've set a target of making 50k on a simulator account before losing anymore of my cash!'

The simulator I'm using at Capital Spreads starts off with 10k, I'm on 15k, like you say cut your losers and maximise your profits, let some winning positions run and bank some!

'Word of warning and advice. To take or throw away with your money.

You have made 5k on a 10k account in 5 days, this amounts to 50% on account in a single week. To get your 15k account to 50k will take a considerable amount of time. If you do achieve this within 1 year that would amount to a trading performance of 400% on your original capital. To achieve these figures means you are playing with extreme risk which over time results in inconsistency and eventually total loss of funds.


There's a very interesting psychology at work in some forum discussion boards - if you can spot it then I think you can save yourselves money in the future.
  1. As speculators pile in (they think they're investors) all the talk is of how this company will change the World, its revolutionary, it's going to be worth  pound; stupid per share. The share price duly rises as the speculators jump in.
  2. Any questioning of how good the product or company is are met with vitriol   claims that you are a 'deramper' or you don't know what you're talking about, or you're a shorter. The more speculators involved, the more nasty the replies.
  3. As the bubble bursts there is no question that it's because the company was overvalued, or the cracks are showing, it's purely down to 'derampers,'   'shorters' The vitriolic comments continue as the speculators are blinkered into their dream of getting rich quickly   easily. The speculators pile in for more to 'average down'   to make money on 'the bounce.'.
  4. The price drops even further   continues to fall, but it's still just down to shorting   deramping.
  5. The shit hits the fan   the bottom drops out of the price. Then the complaint isn't against shorters, its 'corruption,' 'lies,' 'dodgy stockmarket,' 'management,' 'insider dealing,' etc, etc - its everyone else's fault   the speculators feel they have been conned.

It kind of follows the DARA pattern (Denial, Anger, Realisation, Acceptance), with people reaching different points at different times.

Denial that there is anything but blue skies in (1), (2),   (3)
Anger at suggestions of anything other than blue skies in (2), (3),   (4)
Realisation from some in (4)
Acceptance in (5) -   thats when they look for someone to blame.

I've seen it all over the place   thats why I like bulletin boards - you can see how people are thinking. I saw it at SEO for example - bioplastics,  pound;35 per share by Christmas, etc, etc. Up to 35p on the back of 1, 2,   3, down to 0.002p on 4,   5.

Watch out for it.


Q. Have been trading the FTSE and Dow at £5 and £100 per point...

I have been trading the Dow with some success but only at £5 per point, however for the last 10 days I have been playing demo account of my own (no money) at £100 per point...

A: I don't wish to sound patronising but £100 p/p even in a demo account is enough to turn my blood cold. Even £5 p/p on index trading is pushing it. Please use stops (guaranteed or otherwise). The DOW has moved in recent months as much as 700 points in a day. £5x700 is a lot of wonga to lose. £100x700 is...well I'll let you do the Math! Please be careful, nobody here wants to hear of losses of that magnitude.

What you do is your business, just make sure you never lose more than 1-3% of your pot on any one trade because if you do you'll soon be wiped out. Let's take the 1% risk scenerio. I doubt it is possible to trade FTSE with less than a 10 point stop, so...10 x 100 = 1000 deduces a trading account of £100,000. Since 15-20 point stops are more the norm, then you really need a trading pot of £150-£200k to be trading £100pp. This simple maths will keep you safe for a very long time.

Q. I like your comments about trimming your positions. One thing I ask is how do you exit in thirds on a spreadbet?

What you say about trimming down would also work on trimming up to reduce the impact of a trade in positive territory being wiped out by a reversal. It seems an inherently wise thing to do.

As you say the trade costs is an issue for holding actual securities, especially if your trades aren't big in the first place. All this is very a la Mark Douglas, Trading in the Zone. One thing I ask is how do you exit in thirds on a spreadbet? Do you mean reduce the Pounds per point?

A: On some accounts you can do that by adjusting the existing bet - on others you do so by merely placing a new bet in the opposite direction (placing a down bet stake of say  pound;3pp and thereby reducing the existing  pound;10pp up bet to a  pound;7pp up bet).

One thing I like about the IG platform is that bets are displayed in a way that it is possible to exit multipart bets in any chosen order. If I have opened say three  pound;10pp up bets on the same stock, at different entry prices, and the middle one of those three is the one I want to close, I can do so. With Cantor I can bring up a detail of the three bets but can only exit them 'earliest first' which doesn't always tally with what I would prefer doing.

And I agree with you regarding phased exits on winning positions too. I do that all the time. On DCG this morning for example I opened a down bet and subsequently closed 80% of it, banking the bulk of the gain but allowing a small stake to continue awhile - knowing that if it were to spin back against me it could only do so at a less damaging rate. At 11:20am I closed the remaining 20%.

(my DCG bet was actually a little more complex than that. But banking a big part of a gain and allowing a small bet to run on for a few more points is something I do on many trades).

'I have not failed 10,000 times. I have successfully found 10,000 ways that will not work' - Thomas Edison

Q. How do you cope with a poor run of losses?

I have taken a £1000 account to over £8000 in the space of 5 months, however as soon as I get a bad run of losses, (which again I accept and know it's part of the game), then I try to get the account back up quickly by increasing the risk.

I know patience, discipline etc are required BUT I just seem to let these essential rules go out of the window. Maybe my character just isn't right for spreadbetting?

A: It seems to me that you are wildly overtrading a £1,000 account. If you haven't already done so, calculate your risk of ruin. You should not risk more than 2% on any one trade. To do this, either, put in at least 50 times the typical risk per trade into the a/c to get your risk per trade below 2%, or you risk no more than 2% of the £1000 account.

'Then I try to get the account back up quickly by increasing the risk.'

There's the answer. Unless you can sort your trading psychology out you'll always lose in the long run. Maybe best to stop trading and take some time off. You have an advantage in that you have a load of losing trades to learn from ;-)

'How do you cope with a poor run of loses?'

I know that I have a historical Win Ratio (WR), I also know - with a bit of O-level maths - when my run of poor losses deviates statistically significantly from this Win Ratio.

Until this threshold is exceeded it is just 'noise' and should return to the mean over a sufficient number of trades. It is boring, but interesting, to do the maths. e.g. With a historical Win Ratio of 50% you can expect to get some stroke-inducing drawdowns, when you know these are a normal part of the system performance then it does wonders for the state of mind.

An experienced trader once told me that the secret to cope with repeat losses is to treat all winning and losing as equals. He gets excited by a win and [try really hard to get] excited by a well taken loss. The value in analysis is to look at the plan and say "was it a good plan?". I do my best to limit the 'if only' to passing thoughts...doesn't always work but dwelling is a killer. Trading is a constant round of appraisal, 'why did I do that, why didn't I do the other, if only' etc. And in a way it's how we cope with that 'torture' that defines us. Winning is obviously more fun than losing but even when we win we often say 'if only I had put more on it, or if only I had bought earlier'...etc.

Lastly, the fundamental reason for losing money, apart from money management, is in not getting the trade direction right. If the market is has been in a prolonged downtrend how many trades have you made against the main trend during this time?

Q. The index futures are moving too much - I'm struggling to make money!

A: If you are struggling with the index futures, perhaps it is better to look for a less volatile market to trade in. Hyper-volatile markets are not ideal for new traders and traders with small accounts (it will easily wipe out your account!).

I personally congratulate any intraday trader making money in such market conditions. Hyper-volatile markets (like the ones we have been experiencing recently) come with a lot of noise and I would feel more comfortable staying away from any intraday trading. There are plenty of other markets that are easier to trade at the moment. Longer timeframe participants have been liquidating over the past months followed by slight short covering. Nervousness, fear, panic...all these emotions have been expressed over the past months by the bulls.

Perhaps you'd be better off stepping off and only take positions that have a high probability success rate. Paper trade the rest (but try hard to treat the money as if it was for real!) and analyse your performance in these conditions - remember that stops in a volatile market have to be wide as fake outs are a lot more common

Q. I made an index bet for £200 per point thinking my stop-loss was effectively my deposit/credit limit...

I made an index bet for £200 per point on a 2k deposit going long on the FTSE index and it went against me by 460 points - ok I didn't monitor the position but I thought, fine, I may lose my deposit, my credit limit at most, plus maybe a bit more, but not any more than that..but 85k?! - btw this happened with IG Index

A: IG Index have a deposit factor of 200 on the FTSE, so £200 per pip would require £40k in the account for the bet to be accepted erm not?

Sorry to sound harsh but in any case as bad as this sounds what the hell were you doing putting on a big bet with a 2k deposit? You went £200 a point long in the FTSE and then didn't bother to check the position at all and next thing you know you are down 460 points?! And you didn't put a stop loss on at £200 a point!!? If your pockets are deep enough to not bother checking a position with a £200/point bet on an index with almost record volatility then I suspect 85 big ones isn't going to be a hit. Either that or I'm afraid you're very naive...

This is gambling. Roll the dice on number 7. Oops, I've lost...

Spread betting firms are not obliged to close out positions, they will just issue you with a margin call.

 ...Continues here - Impulse Buying and Panic Selling

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