Ride the Winners, Try the Losers but Weed Out the Laggards

I have found through the years that most people have the hardest time cutting laggards and when they find themselves hanging onto a stock that isn’t doing anything but going down, they cling onto hope that someday their investment will at least return to even.

I can understand how psychologically a person can become "stuck" in a languishing stock simply because it is money that isn’t truly "lost" just yet and the person holds onto the "hope" that eventually the stock will come back and they will return to even. Unfortunately, what typically ends up happening is the stock continues to move lower, not only taking the trader's capital with it, but draining emotional capital along the way, as well as the unlimited amount of lost opportunity cost associated with tied up funds.

Most successful traders will agree that the biggest secret to becoming and remaining a successful trader is cutting laggards quickly. Each and every day, around 3:45 pm, I diligently sift through my position sheet looking at each stock I own and making a decision on whether the stock remains or is cut. I am proud to say I do this with a very cold heart and little to no emotion at all as I know these are not people or relationships. They are merely vehicles that assist me in making money. When they do not do their part, they are cut, with no questions asked.

I think it’s important to understand that hanging onto laggards is not the same as trying losers. Making this distinction is important because I am a firm believer that a trader can try anything as long as they have a strategy and exit accordingly should they be wrong. There is a big difference in trying to catch a bounce in a housing stock such as Toll Brothers (TOL) or Centex (CTX) as opposed to riding down and sitting with a Circuit City (CC), but just like any other trade, should the strategy go wrong, the trader must exit quickly or else they have fallen victim to the same scenario.

Those who follow my trades know that several times a week I will say a simple phrase: "Know your lines and your strategy for each position." This simply means that lines or the place in which a trade goes wrong and is cut should be firmly established and monitored often. Furthermore, it is important to always remember what the strategy was for the trade. If you find yourself deviating from this, it is time to re-evaluate and possibly make some changes.

I strongly encourage each person to run through their position sheet and be completely honest with themselves. Are you holding onto hope with any laggards? Do you firmly know your plan with each position? Do you know where you will cut each and every stock you own?

I am firmly convinced that most people could improve their trading dramatically if they would simply resolve to stick with a stop on each position and never let one slip beyond their original cutting point. Keep the portfolio fresh and healthy, never full of laggards.