Compound Money, Not Mistakes

When a position results in a loss just after buying, most likely the trade was a mistake. It may mean missing an element in selection norms, or the timing could be wrong. 

Many investors understand that they should cut losses to control risk. Yet they persuade themselves to wait. Trading is difficult enough without undermining one’s own rules. 

Being disciplined means taking lots of small losses to keep safe. Mark admits that his performance went from average to outstanding when he made up his mind and decided to never have a “just this one-time” moment ever again. He decided not to break the rules because it doesn't pay. 

Paul Tudor Jones has a message over his trading desk: “Losers average losers.” Those three words comprise impactful intelligence that only losers average down on losing positions. That message knocked the author for a set of reasons. First, if a wizard-like Paul Tudor Jones makes that statement, then it’s worth paying attention. Second, if one of the greatest traders was compelled to post such a sign, it is evident how alluring it is to “average down,” and how important it is to remind yourself not to do it.

A stealthy probability of the 50/80 rule is very important to compound money and not losses. Once a stock establishes a major top, there’s a 50% chance that it will fall by 80% and  80% chance that it will fall by 50%. 

This is a warning about being aware of the first loss to hit the radar. Every major reduction starts as a minor retreat. If a person is disciplined to notice trading rules, he will limit his losses while they’re small.

Professionals are consistent and bet only when the odds are in their favour. They avoid risking money on low probability trades.

Buying a stock that is suddenly cheaper can be a trap instead of being a good bargain. When a trader buys a so-called cheap stock and it moves against him, it is difficult to sell because it becomes even cheaper. Then it becomes more attractive based on the cheap rationale.  

When a leading stock tops, it may look inexpensive after a decline, but it’s expensive. This is because stocks discount the future. Usually, after the decline, the P/E ratio rises because of negative earnings comparisons or losses showing up on the balance sheet. However, it's too late by then. People are not willing to buy such stocks irrespective of how high quality they are, making them just worthless pieces of paper.

One must strictly stay away from stocks whose price action does not confirm the fundamentals.

A series of small successes bound together over time result in big success. Mark too initiates with a considerably small position. If it works, he adds more positions or more stocks. If he succeeds in a few trades, then he prefers to go aggressive and increases the overall exposure of his portfolio. This process keeps him out of trouble and helps to win big when right. Trading smaller while trading the worst is controlling risk. 

The goal in trading should be to execute a strategy one can consistently rely on, realizing that the result of a single trade does not define success; rather, it’s the combined outcome of all the decisions and trades over time. 

Mark shares his general trading rule. He never allows any stock to go into the loss column if it has risen to a multiple of his stop loss and is above his average gain. When the price of a stock he owns rises by three times his risk, he moves up his stop. If the stock rises to twice his average gain, he moves the stop to breakeven or equal to his average gain. This protects from losses and also safeguards confidence and profits.

To attain consistent profitability, one must protect his profits and his principal. There is no difference between the two. Once a trader makes profit, that money belongs to him. Yesterday’s earnings are part of today’s capital. Novice investors treat their income as the market’s money instead of theirs, and in scheduled time the market takes it back. 

The marketplace is full of publicity and exaggeration. To trade successfully, one must know how to make his own decisions. A trader’s best and most robust protection is to have a strategy and rules that direct his actions. 

If he wants invariant success, he must apply discipline unfailingly. He can’t have one without the other.