BY LAMON RUTTEN

A Cut Loss Lesson from Successful Investors

Successful investors in commodity markets are more often wrong than right.

Read that again! Yes, you read it well. To be a successful investor, you do not need to be successful in forecasting commodity prices. In fact, like many successful investors, you should assume that you’re only right around a third of the time. And wrong, two thirds! 

Instead, what you need is the willingness to learn about the markets that you are going to invest in, and discipline. A lot of discipline. When investors lose a lot of money, it is very often because they let their emotions overrule their discipline.

And there is no more important disciplinary rule than the one in the heading of this blog. Cut your losses, let your profits run – a maxim first used already in the late 19th century. What does it mean? Essentially, letting your profits run means that if you have made a right call and the market indeed moves as you had expected it to do, you stay in the markets until you have a clear indication that the market is reversing. Many novice investors do the opposite. When they see that they are making a profit on their trade, they want to play safe by cashing it out before the profit disappears again. So a novice investor, when he is right, will only make a small profit.

And when a novice investor makes a loss, he hopes that his luck will turn and the loss will disappear… (probably by definition, investors are optimistic people). So he stays in his position, and will only close it out when the losses are so high that he can no longer bear them. Ironically, that is often just before the market does reverse. So a novice investor, when he is wrong, will make a large loss… 

But it doesn’t matter how often you are right, but how big your profits are when you are right! And how small your losses when you are wrong… So, good investors need patience when their trading decisions prove right – let the market run its course before cashing out. And they need the psychological strength to admit, without any emotional baggage, that they are wrong if the market moves against them, and just accept a small loss and move on.  

Tackling the Dynamic Market Like a Successful Investor

Of course, markets rarely move in a straight line. Even if an investor is right that there are fundamental factors that will drive up prices, it may be that there are technical factors that first bring them down. Because of this, investors need to be willing to put enough money at risk to stay in their position long enough. They need to put sufficient margin, and have realistic stop-loss orders. It will pay off for investors if they analyze their actual experience in this respect - how often does it happen that they are right in their determination of the price trend, but thrown out of their position because of an adverse short-term price movement? In this regard, no serious investor should trade with too much leverage (say, expect that with a margin deposit of US$ 100 they can have an overnight position in a US$ 10,000 contract), their results will become largely a matter of luck rather than skill. 

Another aspect of this maxim is that as an investor, you have to be willing and able to take losses – small losses, certainly (if you do it right!), but you may have quite a few of them before you trade successfully on a big price movement, and, letting your profits run, you make it big! So, never put too much of your money at risk in one trade, but spread it out. 

So a good investor is disciplined and controls his emotions. When you predict that a price will increase to a certain level, and it indeed starts increasing, then trust in your analysis and wait until that level is reached before you cash out – unless if you get new information that changes your analysis. If this continuously fails for you, have a hard look at your analysis – it may simply not be good enough for that particular market. And when your prediction turns out wrong, that is OK, as long as you don’t wait for your luck to change – this is a normal part of the life of a successful investor who, don’t forget, is more often wrong than right!