When I first was drawn to trading I was a little intimidated by parts of the new language (e.g. diagonalized calendar spread or strangles or going naked) and I was a little amused by some of the cliches. Sayings like "you can't go broke making a profit," or "the trend is your friend" easily reinforced some conventional wisdom with something I could easily remember. Some of these sayings have become so well known that I have wondered how often and in what ways they may be applied. Are they 'truths' of the market? Are they infallible? Is there some other side? Do they really work? I'm going to take a look at a couple of these cliches in this article and give you my own thoughts. Mostly, these are just my opinions and I would encourage you to form your own. Just doing a little thinking about the meaning of some of the cliches might give us some new insight.
The first saying that might be worth looking at is the idea that "buy and hold" is the best (and as at least one subscriber noted) and perhaps the only way to succeed in the markets. I devoted a little space in my book, "Trade Your Way to Wealth," to an analysis of "buy and hold," and, suffice it to say I don't see how the strategy "buy and hold" answers the question: "Hold 'til when?" " Buy and hold" is a strategy based on the historical fact that markets go up over time and if one holds a position in a stock, it is probably going to increase in value over time. Depending on the specific stock and depending on the time frame, that may or may not be true. What the strategy really lacks, in my view, is an exit. Is the exit "buy and hold" hold until death? What else is it? When do you get out of a losing position if your strategy is to buy and hold? How does that thought correlate with the next important cliche: "Cut your losses and let your profits run."
It seems to me that if you are going to buy and hold (does that mean buy to hold?) you have no way of cutting your losses. Though your profits may run, they may also disappear, and even turn to losses if there is no exit strategy. I personally am a believer in cutting losses and letting profits run. Hardly anyone would disagree with the general principles in that cliche. The problem I have seen is that so many retail traders don't have a clue how to cut losses or how to let profits run. It does suggest the need for some plan on the trader's part that will define when, or under what circumstances, the trade will be closed. There are many ways that creating an exit strategy can be accomplished and it is up to the individual to chose the strategy that best fits his own trading needs and personality. One trader may decide to use a cross above a moving average as a reason to enter and a cross beneath the average to be a reason to exit thereby making the moving average the strategy. Would that help cut losses? Sure it would in most cases. That strategy could also let profits run because there would be no exit unless and until the stock price dropped down through the moving average. A different trader may choose to move stops behind his position either on a trailing basis or at a specific stop price that he could regularly move behind his position. I discuss this concept in "Trade Your Way to Wealth" and believe it is an important concept for every trader to incorporate into his personal trading plan. I don't mean to suggest any specific exit strategy is better than some other one, but I do mean to suggest that I think is better to have some disciplined exit strategy in place than to have none at all.
I hope that is food for a little thought. Down the road, I think I'd like to take a look at "buy on the rumor and sell on the news" and maybe "you can't go broke making a profit." Maybe even think about "the trend is your friend" or "you earn on the turn". Let me know if you are aware of some market saying that we might have some fun thinking about.
by Bill Kraft, Editor
Copyright 2008, Makin' Hay, Inc.
All Rights Reserved
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