Cut losers short… Shoot, you COULD stop that popular saying THERE!

I just had a fella post a question/comment to my blog:

“If you buy a put for insurance, doesn’t the put take away from your gains if the underlying stock goes up?”

Short Answer: Yeah.
FURTHER Answer: Your point being? Cutting losses short almost makes my whole trading plan take care of ITSELF.

Heh… well, without trying to sound TOO smug, here’s the deal: when you have very small losses, you don’t have as much ground to make up either. So a more modest return is okay.

Consider this: say you were trading long stock (no margin, no leverage from a long call… just stock) within the last three months, you might have seen gains of 20, 30% or more.

But you might also have suffered losses in the last few sessions of 20-30% as well. Hope I’m not striking a nerve… but if I am, that’s all the more reason to pay attention to this particular blog post. Because if you truly GET the principle of expectancy and skewed risk/reward… it can make you rich.

Let’s use the example provided by the market’s last two weeks or so. Take the middle of the road: 25% losses. A 25% loss needs a 33.33% gain just to recoup losses. With 25% loss and 33.33% gain, you are even-Steven… same place as you began.

On the other hand, say your married put positions only gained 12% on the way up… like my 1st ALTR play (described elsewhere on this blog). While the stock went from $27.35 to $33.10 during my holding period of seven weeks… a  17.3% gain…. my married put play only picked up 12%. Boo hoo, Kevin was right… my Married Put play limited my gain. 12% versus 17.3% means not as high performance as straight stock. Shucks.

But then… my second Married Put play with ALTR lost 5.6% during a period of time that the stock itself lost 21.8%. It’s down even MORE now but my max loss would still be locked in at 5.6% if I got out today.

I just closed that one last week. Now you tell me… had I been playing stock only during both of those time-frames, it would have been 17.3% on the winning play, 21.8% on the loser. Assuming similar position sizes,  am I ahead or behind? Door number two, sorry… I woulda lost with ALTR overall.

But as it stands with my Married Put setups… yes, I “only” took 12% on the way up, and lost 5.6% on the way down. Again… the position sizes were almost the same. You guessed right: in the SAME market with the SAME stocks, entered and exited at the SAME time… The Married Put plays leave me ahead.

That’s only being right 50% of the time. Think about it… would YOU play a coin toss game in which winners paid 12%, and losers took 5.6%? Knowing what you do about probability and statistics, would you want to play this game from sunup to sundown? Heh… I sure would.

Remember when I said that if you truly GET this principle of skewed risk and reward, it could make you rich? Now’s the time to go back up to the top of this article and invest the two or three minutes it took you to get to this line… once more. 😎

Hey, sound off below, folks… would you like for me to show the charts, entries, setups for both the winning and the losing trades on ALTR? Again, if I had traded a covered call or long stock it would be a net loss. But since I was playing a Married Put on both, we have a net win. Who else would like to see that graphically?

Happy Trading,

Kurt

About Kurt Frankenberg

Kurt Frankenberg is an author and speaker about entrepreneurship, martial arts, and trading the stock and options markets. One of several “Biznesses” he founded as a teen, The Freedom School of Martial Arts, has been in continuous operation since 1986. Kurt lives in Colorado Springs with his wife Sabrina, German Shepherd Jovi, and his ninja cat Tabi.