Why Cutting Losses Is Better Than Depending On Hope

``Good traders, we think, don’t stand around and tell you how wonderful they are when they are right; most of time good traders only talk of their losers. Good traders’ reverse the natural tendency to attribute winning trades to brilliant analysis, and losing trades to bad luck; they understand what Livermore meant when he said, “In trading its better to do right, than be right.” The functional reality of this type of mindset is to limit the ego—which wants to seep in and control all.”-Jack Ross Crooks III, Black Swan Capital

Well to all those who still insist on clinging to the “ladder of hope” on this apparent monumental shift in market directions, I’d offer you a simple arithmetic which would enable you to reassess on your commitments.

Table 1: Returns Required to Break Even

Table 1 tells us that IT TAKES MORE EFFORT for the bulls to recover from their losses than to take losses and wait for the opportune moment to reenter the market.

For instance, a loss of 25% requires 33% in gains to offset the nominal losses (excluding transaction costs-which mean gains should be even larger). Similarly, a 50% loss translates to 100% (++) of gains in order to reverse the losses. As the losses worsen, so does the magnitude of gains required to neutralize such losses.

To sum it up, taking action by minimizing losses is A LOT BETTER than foolishly indulging in the hope of a recovery. As we always say, financial markets are mainly about opportunities management which should incorporate rationalizing costs relative to benefits.