Only Losers Average Losers
06/01/2012 2:00 pm EST
Scaling into rising stocks is part of a wise trading strategy, says Bob Weissman, but averaging out of losers is never prudent because it leaves valuable capital tied up in undesirable assets.
We’re here with Bob Weissman. Bob, when you’re in a stock and it’s not performing as you had hoped, the question that most people always have is do you or don’t you average down and look to regain it if it looks like it still could be a winner?
Exactly. One of the things that Mark Minervini has always taught me is to never average down. In the seven plus years I’ve been working with him, I’ve never seen him do it once.
There’s actually a pretty good story that Mark teaches: he saw early on his career a picture taken of Paul Tudor Jones, and behind him is posted “Losers Average Losers.” It’s in big letters on his wall right next to his trading screen.
Mark said to himself that if one of the best traders in the world has this as a reminder next to his trading screen every day, there might be something to that. So he took from that to realize that you’re always going to hurt yourself and put yourself in a worse position.
The whole point of what Mark does is to scale into stocks that are performing properly; that is, they’re going up if we’re long. An expression that he uses all the time is “While you’re trading your best, you’ll be trading your largest, and you’ll be trading your smallest while you’re doing your worst.”
That’s because you’re only putting more of your capital to risk as the stock is moving the way you want, and so you’ll have the maximum exposure as the stock is performing up and/or positively.
And if your stock isn’t performing well, you’ll have just a small exposure to it. Then immediately take that stop loss and get out when it’s not working out.
So say you have four stocks and you establish initial positions in all of them. Three of those stocks start moving up as you hoped they would.
You keep your stop loss on the fourth stock that’s losing money. Then, if the trade hits the stop loss, so be it; if it turns itself around, great. But once the trade hits the stop loss, you’re out, no questions asked.
Then does all the money that was going there get transferred over to the other three?
Don’t necessarily do that, but what you’ll do is scale into the name that works as long as it continues to meet our specific entry point analysis set-ups. That is, having very low-risk entry points where our risk is defined and it is the minimum amount of risk for that maximum potential return. That’s where you’ll continue to add into it.
Don’t just throw more money into it because it’s going up. It still has to meet our criteria to get in at that entry point that’s specifically set.