I’m sure you’ve heard of the saying, “Cut your losses and let your profits run”.
This is probably the most commonly quoted piece of trading advice on the internet.
For years, I tried to abide by it as I struggled – just like everyone – at the beginning of my trading career.
But it wasn’t until I started to think for myself, that I realized it’s probably one the worst pieces of advice anyone can give a trader.
Yes, I said it.
For the most part, I believe trading advice should only be given and taken with respect to a specific trading method.
There’s no such thing as useful generic trading advice.
Generalist or Specialist?
In many areas of life, general advice can be useful. For example, “don’t spend more than you earn” is general advice that’s useful for most people.
But successful trading isn’t like most other areas of life. In fact, it’s one of the most radical things a person can do.
After all, it requires one to think and behave differently from everyone else – that’s the only way to make money over the long term.
You see… to be a successful trader you need to be a specialist.
Regardless of the currency pair you trade, regardless of the charting time frame, doing well in trading requires you to specialize in a narrowly-defined trading method.
And a specialist has no use for general advice.
Cut Losses & Let Profits Run
To me, this is bad advice because it is generic, contradictory and impractical.
The worst part is, it sounds like it isn’t.
It sounds legitimately useful.
If I’m a short-term scalper, for example, I shouldn’t be letting my profits run – I should be taking profits at a predetermined level.
Any intraday trader worth his salt will tell you that short-term trading often involves taking counter-trend trades, called fading.
And allowing your profits to run instead of booking it quickly can very well turn that winning trade into a losing one.
The problem is that too many traders believe that “letting profits run” is good advice, when it is fatal in many situations.
If you really think about it, the spirit of the message behind “cutting losses” contradicts that of “letting profits run”.
“Cutting losses” means to close a trade soon after seeing a paper loss.
“Letting profits run” means to refrain from closing a trade when there is a paper gain.
To illustrate why this is contradictory advice, allow me to provide an example:
Traders A and B are trend traders. They are both looking to long the market, and the only difference is where they got into the trend.
Trader A got in early on the trend. When the retracement occurs, he follows the advice and allows his profits to keep running.
As you can tell, he’ll do very well on this trade.
Now, Trader B got in late into the trend.
Almost immediately after entering the trade, the market price starts to retrace and the trade suffers a paper loss.
According to the advice, Trader B should close the trade and “cut the loss”.
Later on though, the trend resumes and it becomes clear that Trader B should have held on to the trade.
Notice how, by following the same advice, one trader enjoys a larger profit while the other suffers an unnecessary loss.
How can two traders get such different results trading with same advice?
This happens when there’s a contradiction in it.
Now let’s take a look at the same Traders A and B, in a different (reversing) market situation:
If Trader A followed the advice and held on to the trade to “let profits run”, he would end up giving back all his profits, or more.
What about Trader B?
By following the advice, Trader B would have cut losses early and avoided a much larger loss.
This time, Trader B is the one that made the winning decision, while Trader A did not.
Again, we see two very different outcomes with the two traders following the same advice.
Notice that in either scenario (trending or reversing), there is one trader who made the right decision, and one who made the wrong decision.
Again, this can only happen when the advice is contradictory.
You see… the trader who makes the “right” decision is ultimately determined by how the market moves. It has nothing to do with how useful or effective the advice actually is.
If anything, it will likely cause endless confusion among the traders who follow it.
I suspect the reason why this piece of “advice” keeps popping up – despite its inherent contradiction – is that there is no situation in which it can be proven to be wrong. After all, one of the traders will always be seen to make the right decision, regardless of how the market subsequently moves.
This is why I consider all trading advice to be impractical unless it is given with respect to a specific trading method.
Instead of just saying “cut your losses”, it would be more appropriate to examine a specific trading method and say, “close your trades when your indicators tell you the trend has changed”.
Now this advice is specific, clear and actionable.
Telling a trader to “cut losses and let profits run” is like telling someone “don’t buy losing lottery tickets and buy more winning lottery tickets”.
It’s not something that can be done on a practical level.
So if you must give (or take) trading advice, make sure it is targeted towards a specific trading method.
Make sure it is specific, consistent with the trading philosophy, and practical enough to be implemented.
So share with me our opinion… What’s the worst trading advice you’ve heard?