V.9:1 (43-46): Trading Simply: Minimizing Losses by John Sweeney

V.9:1 (43-46): Trading Simply: Minimizing Losses by John Sweeney
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Trading Simply: Minimizing Losses by John Sweeney

Richard Dennis is said to have said, "There's a lot less to trading than meets the eye." If so, he was correct. I like to describe an approach that has nothing to do with entry or exit, but everything to do with minimizing losses. I believe virtually any system that can identify successful trades can be profitable, given good loss control. Here's how.

FUNDAMENTAL RULES

Approach trading, particularly futures trading, as a zero-sum game. In such a game you can only win if someone else loses. Stock trading is not such a game, definitively, since its total value can rise and fall. However, I see no reason that rules sharpened in the harsher regime of futures wouldn't serve well in stocks. (Idea: what to make of instruments such as index futures, which are traded in zero-sum markets but derive from non zero-sum markets?) Thus, as a practical matter:

Rule 1: The theoretical solution to a zero-sum game is to minimize the size of. your largest loss. Every trader has heard that adage before: Cut your losses.

Rule 2: Trade a small percentage of capital for any one position, preferably 2% or less. I don't know a serious trader who commits more than 5% of his capital in any one position, and most are around 3% . I've had people ask me what their returns will be if they commit 10-15% of their capital to their positions! Their return would be a wipeout, because the probability of ruin is very high and very quick—say, three months.

Now, to keep the loss in proper proportion to capital without being stopped out of positions, you need a technique for estimating the size of the losses you'll take. I'll show you how to estimate this precisely, but first, one more general rule:




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