Many years ago Paul Tudor Jones was photographed in front of a photo that read “Losers Average Losers”. What the heck does that mean and why is it so important? As traders our #1 job is managing risk. If you add to losing positions it may become extremely difficult to manage your risk. For example, If you put on a position with X dollars of risk and the position moves against you and you increase the position size very quickly a position with an initial risk of X can become 5X or more and jeopardize your monthly return or even your career (as happened to one of our traders last year who lost 20X his daily limit). In our training we teach to not “double down”. We do this knowing that most likely 80% of the time you can get away with it, but understanding the other 20% of the time will wipe out the rest of the gains or far worse.
Now there are two important caveats to understand that I teach our traders and you can clearly see if you look at PTJ positions in this blog post by Frank Zorilla. Traders may put on what is known as a very small position known as a “feeler” that represents a miniscule amount of risk and usually is designed so that a trader will pay attention to a stock and enter with a full size position if it reaches a pre-determined price level or its “price action” indicates that the risk/reward has become more favorable. This technique is used by myself and many traders on our desk and can be applied to many different time frames. It in no way impedes a trader’s ability to manage their risk.
The second caveat is sometimes in a planned trade we have an ideal entry that offers a very high risk/reward at which point we would be willing to put on a full position, but we aren’t sure if a stock is likely to reach our ideal price level. So we will enter with a smaller amount of risk, perhaps 25%, and increase that risk if the stock trades to our ideal entry price.
If you increase a position as part of a trading plan or because the initial position was simply a tiny “feeler”, as was the case for the PTJ fund, you are controlling your risk and should be fine. If you decide to increase your position without a well defined plan simply because the stock is now “cheaper” you greatly increase your odds of ending up on the dust heap of history with thousands of others who have “blown up” their accounts or funds.
Here are some related posts:
Losers Average Losers: Trend Following Principle
Here is one of my favorite charts from the past few years. A former trader who I worked with was supposedly an “expert” on the coal sector. I watched him load up several different times on WLT’s journey from 30 to 10. It currently trades at 55 cents. Although he never doubled down he was always positioned on the long side, which eventually caught up with him.
Steven Spencer is the co-founder of SMB Capital and SMB University which provides trading education in stocks, options, forex and futures. He has traded professionally for 18 years. His email address is: [email protected].
No relevant positions
