This is an important rule in trading. In my earlier post, I mentioned about my experience of how I was shaken out from my trades in Bidu, AAPL, and AMZN the last few years.
A rising trend can be like riding a wild bull in a rodeo. You can be hurt if you do not know how to fall. But the real success is when you are able ride the bull as long as possible. I said that one of the keys to superior performance is to be able to ride the bull longer. This is the only way to achieve vastly superior returns. You will never have a multiple fold winners if you sell early.
Most people find it hard to follow the rules of let your winners ride and never allow a small loss to turn into a big one. As soon as they see a little profit, they sell. When they are losing money, they hope and hold. This is the exact opposite of what you should do. It is against your natural instinct.
But it is important to know when to get out. My personal red alert is when the loss climbs above 10%. The maximum I am willing to keep a losing position is 20%.
In a volatile market, you can be whip sawed at 20% easily. Fortunately, with consistent option hedging techniques you can contain it within this level. If it gets above this level, I know I am out of control with the trade structure.
The important thing is never let a small loss turn into a big one. You do not want to be seriously hurt that you are out of actions. You want to be able to get back on the ride again.
Potental Loss Amount to recover
-10% 11%
-20% 25%
-30% 43%
-40% 67%
-50% 100%
-60% 150%
-70% 233%
-80% 400%
-90% 900%
Note that at -10%, you need only to recover 11% to break even. If you lose 50%, it will take 100% to recover. It is almost impossible to recover if you lose 90%.
One of the secrets is to keep the trade hedged. Let go the hedge only when the trend is very clear. If you are not sure, keep the hedge.
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