Recently I had a buddy of mine called me wanted my view on a situation that he found himself in. He was experiencing a typical trading dilemma for someone who trades in multiple financial markets. He had two positions on where one was in the profit a massive amount, while the other one was in the loss by a huge amount. One of his long trades in the equity markets was in the profit by a huge amount, while another short trade in the currency markets was showing a big loss.
Pretty sizable paper profit being canceled out by an equally sizable paper loss. None of them were realized yet.
He was wondering what to do? Should he liquidate the losing position? Should he double down on the losing position? He wanted to know my view.
I thought about how if he had just picked the winning position in the equity markets and stayed out of the bad currency bet, he would of been in the profit by a huge amount. Because sometimes trading is all about staying out of the bad trades, because the good trades will take care of themselves.
My buddy is a pretty good trader and had fairly sound order flow analysis to justify both trades. But it just happened that one of them was working out spectacularly, while another one was failing miserably.
What usually happens in these situations is that I tap into my knowledge base of various trading images, articles, quotes rattling around in my brain as well as draw from my own experience to try to give the best possible advice.
The first thing that came to mind was an image of Paul Tudor Jones sitting in his office with the words
Losers Average Losers
Then I remembered the famous trading quote:
Cut your losses and let your profits run.
I told my buddy to close out the trade that wasn’t working for him and take that money and pyramid into the position that was already in a huge profit. He responded by telling me the stock was already too high to buy some more. I told him that there must be a reason one of his positions in the profit by a massive amount and the other position is losing by a huge amount. Maybe the market was telling him something? He did give the losing positions a few days to work out, but it just wasn’t going his way.
Then I remembered about the trading quote from Reminiscences of a Stock Operator:
Prices are never too high to begin buying. Prices are never too low to begin selling
My buddy heeding my advice to sell out of his losing trade, but opted not to increase his exposure to the winning stock position. Turns out a few days later the same stock posted a huge earnings surprise and the market gaped substantially higher. If my buddy had pyramided into the winning stock position, he could of converted the paper profit of the extra pyramid position into realized profit when the stock gaped higher on a surge in order flow related to the earnings release. That way he could of made a killing and still maintained his substantial long exposure to the stock.
He still made a killing, but he could of made an even bigger killing if he got over his fear of buying when prices have already risen substantially. Nothing wrong with his trading decision. He chose the more conservative approach.
Sometimes when prices are high, it can signal an overvalued market, other times the market may be reaching for a new, even higher degree of fundamental value where the reason will only be known at some point in the future.
Sometimes the financial markets do that. They may post consecutive trending days in a row, as they move towards their new sentiment or fundamental value as perceived by the stronger order flow force. The order flow reason sometimes can come a few hours or a few days later.