I Never Take My Losses Quickly (Why I Use Time Stops)

Last Updated on June 19, 2022 by Quantified Trading

To get inspiration and motivation I read a lot. Not only trading books but also from other completely different topics.

Actually, I learn more from books that are not related specifically to trading. Other fields can be related to trading so no need to only read trading books which more or less are 80% the same. I mean, how many times do you want to read “cut your losses and let your profits run”?

And by the way, so much of the trading literature is simply wrong or grossly exaggerated. You need to think outside the box and find the least populated path.

One of my favorite trading books is Pitbull by Marty Schwartz. Schwartz claims one of his keys to success was to “take losses quickly”. Even though it’s a good book (highly motivational) I still find this saying completely out of tune.

It’s a typical saying which no one actually tests. Schwartz was not a mechanical or systematic trader (and I have no idea if he’s still trading). How can you tell if it’s such a great idea to take losses quickly?

Why do I use time stops?

If I cut my losses quickly it would cause havoc to my profits. Almost all of my positions are at a loss before they turn into profits. Granted, I’m a short-term investor (occasionally a long-term investor) and only trade mean reversion. Perhaps it’s different if you are trend following (also another saying I’m highly skeptical to. What is a trend?). It’s impossible to find the top or the bottom. If I “cut my losses quickly” I would have nothing but losses. As a matter of fact, I usually scale in and out just because of this.

I only exit at different time intervals. That works very well for me. However, sometimes the loss only gets bigger and bigger, like yesterday, where a lot of stocks simply trended throughout the day. But it does not happen often. A big loss halfway in the day usually gets better. Instead of cutting losses, it makes a lot more sense to exit at the same time day after day.

Again, the best risk management you can do is to trade a lot with high frequency, different stocks, different strategies, and different markets.:

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  • If your strategy is based solely on quantified edges, the problem of when to “cut losses” relates to the theorems of “stopping time” and “optimal stopping”, where the solution lies simply on maximizing expected return, given model properties. If system innovations or evolving markets makes one doubt the numbers of the past, one like Schwartz, rest on trader intuition or discretionary behavior; the optimal stopping of a Martingale (random) process comes to mind; as the expectancy is at best zero or below and over time with limited wealth (leverage ability) the house always wins. How much to listen to the quantifiable (or improve such) and how much faith to put in the trader?

  • Good Stuff. I use the time intervals as my primary exit for short term trades as well. I think the notion of, “managing risk with a tight stop” is a primary reason why small traders tend to lose money. I think most of these cliches come from the world of trend following and are not directly applicable to most short term or swing trading methods.

    One thing I remember about Schwartz’s book is that there seems to be a decent amount of space between what he says and what he does as described in his trading stories. I think it is more likely that “cutting losses” is in his case more about not freezing up or continually averaging in to bad trades rather than actually putting close stop loss orders into the market.