Let profits run is one of the most famous Stock Market sayings, however, most people who try to master the world of trading do it trying just the opposite: cut losses run.
This is quite true in short term trading, especially day trading, where Forex, futures, CFDs and binaries have a great importance.
This happens also in stocks, but to a lesser extent. This is so because a significant amount of people who deal with stocks is to have long term investments, which is, actually, the best thing we could do when we approach the World of trading and investing. In this sense, stocks and related products are the best to invest.
The other kind of products, in the so called derivatives, the gambling component wins by far, and the trend is to try to take small benefits and, when our ego betrays us, take big losses
Day trading let profits run
Let profits run and day trading are actually incompatible, because let profits run needs of well established trends, something you cannot find consistently doing day trading.
When a trader tries day trading will have to face the costs associated with it: spread and commission. And those costs are huge when you sum them at the end of the day.
For instance, let us say we do day trading in the ES (SP500 future).
We will let profits run and we will cut losses short.
Let us assume we take profits at 6 points and cut losses at 2.
That is to say, we have 24 ticks for our profit and 8 for our loss.
Cut loss let profits run
The problem is that we pay a spread every time we are in and out, which gives us an additional cost of 2 ticks.
Moreover, we have the commission cost, which could be of half a tick.
The total cost should be, then, 2.5 ticks.
Therefore, every time we win we have to deduct 2.5 ticks, and every time we lose we have to add 2.5 ticks.
A loss will be of 8.5 ticks, and a win of 21.5 ticks.
This resultant ratio is of 2.53, whereas the original ratio was 3 (24/8).
As we can see, we worsen our ratio by a very significant amount.
If we trade 4 times a day we should probabilistically, expect 3 losses and 1 win.
In this case we would have 10.5 loss multiplied by 3, which would be 31.5 loss.
The win would only be 21.5.
As we can see the ratio after that is 0.68 (21.5/31.5).
As a consequence we will have to win a lot more than the ratio 1 win/ 3 losses.
We do not need to be rocket scientists to see that this ratio is very difficult to overcome.
Even if we win 1 time and lose only 2, we are still close to being even.
If you can see this you will understand that doing day trading excessively is not a good idea, at least not for you: the trader.
The example I have mentioned is equivalent of trading binary options with a 75% payout.
I think I do not need to tell you that doing that will not take you very far in your trading career.
Let your profits run swing trading
The best way of taking advantage of this “let profits run” is by doing trading in longer time frames.
As I said at the beginning, the best would be to do long term investing, where our transaction costs would be severely reduced.
The other alternative is to do trading in shorter time frames, like weeks or months: swing and trend trading.
If we do this, especially in futures, we would have very low transaction costs, having to count with swap costs, which in futures we “pay” when we change contracts and in CFDs, every night with the financing cost.
I am not going to say what we have to do or not exactly, but I can tell you that after many years of experience now I know that the best thing you can do is letting your profits run, especially trying to do in trades that last more than one day.
The best way to succeed in the “day trading arena” is to work for the industry, whether it is brokers, market makers, proprietary trading, signal providers, robots, etcetera. This success will not be as a trader, of course, but despite the traders. Besides, this is true for 99.99% of cases.
All the legends in the history of the stock market always recommended let profits run.
Even, speculators of the kind of Andre Kostolany or Jim Rogers would never be cutting profits short every time they say the ticker going two points in their favour.
Even Buffett let profits run with his “value investing” strategy.
As Kostolany used to say: “Who longs for small things will never achieve greatness”.
Perhaps the most legendary phrase is that one of Jesse Livermore book, “Reminiscences of an Stock operator”, when Partridge answered: “well, you know, we are in a bull market”.
If all these great speculators and investors let profits run, why would we try to do different?