What it means
Most people find it easy to lock in a profit and hard to take a loss. A share that rises 10% feels like a win worth banking, while a share that falls 10% feels like a loss that will surely recover.
The principle warns that this instinct leads to small wins and large losses, which is a recipe for poor results. The full saying is "cut your losses short and let your profits run".
The idea is that you do not need to be right most of the time if your winners are much larger than your losers. A trader who wins only four trades in ten can still make money if the average win is several times the average loss.
In practice, letting profits run usually means using a trailing stop. A trailing stop is an exit order that follows the price upward but never moves down, so that it locks in more profit as the price climbs and sells only if the price falls by a set amount from its high.
This gives a winning trade room to grow while protecting a good part of the gain. The principle is closely related to trend following, an approach that tries to ride long price moves.
It also links to behavioural finance, which studies why investors sell winners too early and keep losers too long, a pattern known as the disposition effect. There are limits.
Holding on can mean giving back large gains when a trend ends, and no rule works in every market. The principle is a guide to discipline rather than a guarantee, and it does not replace sound risk management or professional advice.
In practice
Real-world examples.
Example
A private investor buys a share at $50 and sets a trailing stop 10% below the highest price. The share climbs to $65, so the stop rises to $58.50. When the price later falls to the stop, the investor sells with a gain of $8.50 per share, rather than the $3 gain that she would have taken at the first sign of profit.
Example
A commodity trader follows a rule of risking $1,000 on each trade and aiming for gains of at least three times that amount. When a position moves in her favour, she moves her stop to break-even and lets the trade run. One winner of $6,000 pays for several small losses.
Example
A venture investor holds a stake in a small start-up that grows quickly. Rather than selling after doubling her money, she keeps the holding as the business scales. Years later, the stake is worth ten times the original investment.
Formula
Calculation
Expectancy per trade = (Win rate x Average win) - (Loss rate x Average loss)
Worked example: a trader wins 40% of trades and loses 60%. When she cuts profits early, her average win is $300 and her average loss is $300.
Expectancy = (0.40 x $300) - (0.60 x $300) = $120 - $180 = -$60 per trade, which is a losing system.
If she lets profits run, her win rate stays at 40%, but the average win rises to $900, while the average loss stays at $300.
Expectancy = (0.40 x $900) - (0.60 x $300) = $360 - $180 = $180 per trade. Over 50 trades, that is a profit of 50 x $180 = $9,000, compared with a loss of 50 x $60 = $3,000 under the first approach.Case study
Seen in the real world.
Calder Trading is a fictional small proprietary trading firm. Its review of a year's trades showed that the average winning trade earned $450 while the average losing trade lost $520, with a win rate of 55%.
The expectancy worked out at (0.55 x $450) - (0.45 x $520) = $247.50 - $234 = $13.50 per trade, barely above break-even once costs were counted. The review showed that traders were closing winners as soon as they reached a small gain, but holding losers in the hope they would recover.
The firm introduced a rule requiring a pre-set stop on every trade and a trailing stop on every winner. Within six months, the average win rose to $700 while the average loss fell to $400. This is an illustrative story, but it shows how disciplined exits can change the economics of trading.
Watch out
Common mistakes.
- Interpreting the principle as never selling a winner. A trailing stop or a clear exit rule is still needed, otherwise gains can disappear completely.
- Letting profits run but also letting losses run. The two halves of the saying work together, and ignoring the loss-cutting half destroys the benefit.
- Believing it guarantees profit. Trends end unexpectedly, and fees and slippage can erode the gains.
Questions
People also ask.
What is a trailing stop?
It is an exit order set at a fixed distance below the highest price reached. It moves up as the price rises and triggers a sale if the price falls by that distance.
Why do investors sell winners too early?
People feel the pain of losing money more strongly than the pleasure of making it, so they rush to bank gains. Behavioural finance calls this the disposition effect.
Does the principle suit long-term investors?
Partly. Long-term investors often hold quality assets for years, but should still review them regularly and sell when the original reason for owning them no longer applies.
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