Imagine you could pick some top investors to have dinner with. Names like Paulo Tudor Jones, Bernard Baruch, and Warren Buffett would probably top the list. And if you had them as dinner guests, you’d probably want to know their investing rules.
Here’s one they all agree with: Proper risk management.
Paul Tudor Jones has 21 rules for investing. One rule says: “If I have positions going against me, I get out; if they are going for me, I keep them.” Another: “Don’t ever average losers.” Here’s another one: “The most important rule of trading is to play great defense, not offense.” And finally: “Don’t focus on making money; focus on protecting what you have.” What do these all mean? Overall, Jones is recommending an approach to risk where you focus on what you have and try to build it. If he sees a trade not going well, he cuts his losses quick.
Bernard Baruch was a wildly successful American financier. He also spent part of his career counselling Presidents Woodrow Wilson and Franklin D. Roosevelt on economics. And Baruch would agree with the advice from Jones. In fact, we can take some of this presidential advice to our own trading in three sentences: “Learn how to take your losses quickly and cleanly. Don’t expect to be right all the time. If you have made a mistake, cut your losses as quickly as possible.”
Warren Buffett says the same: “Never lose money.” That’s Rule #1. Rule #2? “Don’t forget rule number one.”
Incorporating the Advice
Jones, Baruch, Buffett…these men aren’t any average investors. They’ve learned through big successes and big failures the hard truths about investing. If there’s one rule you should stick by to avoid making the same mistakes, it’s to learn to cut your losses. It’s one thing to lose money now…it’s worse when you lose more later because you weren’t willing to move on. This is what the chief market technician at Day Hagen Asset Management, Art Huprich, has to say about it:
“Realize that a loss in the stock market is part of the investment process. The key is not letting it turn into a big one as this could devastate a portfolio. It’s not the ones that you sell that keep going up that matter. It’s the one that you don’t sell that keeps going down that does.”
Remember these wise words. The best investors follow the simple rule: Cut your losses. You should follow it too.
-Investing Insider Magazine