POP Rule #2–Always Press Your Winners

This post was contributed by a guest author, and does not necessarily reflect the views of Richard or MovetheMarkets.com

The Phantom of the Pits has two big rules. Rule #1 is this:

In a losing game such as trading, we shall start against the majority and assume we are wrong until proven correct! (We do not assume we are correct until proven wrong.) Positions established must be reduced or removed until or unless the market proves the position correct! (We allow the market to verify correct positions.)

This rule is all about cutting losses, sometimes even before they fully happen. This rule is the most important, as it keeps you (and your capital) alive to trade another day. Let the market tell you when you are right–you should proactively know when you are wrong! But now I want to write about POP’s second rule.

Rule #2

After my SOEN trade, I was pondering what Phantom of the Pits said about his Rule #2, which is:

Press your winners correctly without exception.

In its most basic sense, the intent of this rule is to make sure that your net winners are larger than your net losers. The implementation of the rule manifests itself differently depending on your trading system. For day trading, positions tend to come and go very quickly. Putting on partial positions and adding later may not work, especially if there is no “later”. The best implementation of Rule #2 in day trading is in expectancy, where you try to have your winners at your win rate be larger than your losses at your loss rate. A positive expectancy means that you are implementing both Rules 1 and 2 correctly; a negative expectancy means you are not. The higher your expectancy, the better you are implementing the rules. Plenty has been written about expectancy in day trading, so I want to now focus on swing trading–positions held over several days or more.

Swing Trading and Rule #2

In longer term trading, the best implementation of Rule #2 is to make sure that your position is larger when you are right than when you are wrong. This can only happen if you add to a position after it has been proven correct, and that can only happen if you don’t put on your full position in the first place! Putting 2/3 of your position on as an initial entry leaves an extra 1/3 to add if your trade is proven correct. If it goes against you according to your system criteria, then Rule #1 makes you punch out, and you’ve only taken a loss on your 2/3 position size. If the trade is proven to be correct and you have a criteria in your system about when to add, you add the rest of the position according to that criteria.

I took a swing trade in Broadcom Corporation (NASDAQ: BRCM) that illustrates this principle. BRCM pulled a weak rally to the downsloping 20 day ema. It looked like a good place to fade the move. Would I be confirmed correct?

I put on 2/3 of my position size, and waited until the next day for the next step. If it moved in my favor, I would add the final 1/3. If it moved against me, I would get out. Here’s what happened the next day:

Trade Summary:

BRCM Short 33 Shares
Entry: $32.52, Stop: $33.35, Target: $30.00
R: $27.39, Exit: $32.80
P/L: -0.34R, or ($9.24)

The net result is that I was wrong on a position that was 2/3 of normal size. When I am correct on a trade, I’ll be right on a position that is full size. This way of pressing your winners, coupled with cutting your losers will help you maximize your expectancy and give you the greatest chance for success in trading.

Stocks Mentioned In This Article
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This post was contributed by a guest author, and does not necessarily reflect the views of Richard or MovetheMarkets.com