You’ll never go broke taking a profit

Have you heard the phrase before? Have you SAID the phrase before?? (I’ve been guilty once or twice…)

Drop a comment and let me know your thoughts.

The axiom makes sense on the surface!

If you take profits on your investments, you’ll always be ahead! You won’t have to suffer the pain or embarrassment of watching a winning trade turn into a loser. You can pat yourself on the back and say “well done” and add another check-mark to your list of successes.

But taking profits prematurely — just to get a win on the board — can actually be very dangerous for your long-term results. In fact, in extreme circumstances you really CAN go broke taking a profit!

Let’s look at a scenario…

A High-Risk / High Reward Strategy

I manage a few aggressive portfolios that trade option contracts.

Each position is designed to have the potential to generate very large returns. (In some cases, several times the initial investment.) And because these are aggressive positions, each trade has the potential of going to zero.

Statistically, these portfolios have performed well over time.

This year, a few of my trades have been grand slams, returning 5X, 7X or even 10X the initial investment.

Of course, several of the trades have been duds. They have gone to zero and all of the capital on these losing trades have been lost.

Ironically, the number of winning trades hasn’t been significantly higher than the number of losing trades. The success in these portfolios came because the magnitude of winning trades was larger than the magnitude of losing trades.

In other words, I let my winning trades continue to run and accumulate profits.

Imagine if I had followed the old Wall Street adage “No one ever went broke taking a profit” and settled for a 20% or 40% gain on those winners…

My winning trades would have been very small. And my losing trades would have still accumulated the same losses.

Eventually, I would go broke!

“Don’t pick your flowers and water your weeds”

Here’s a better Wall Street axiom:

“Don’t pick your flowers and water your weeds”

Avoid the temptation to sell the positions that are working well. If you do, you’ll wind up selling your winners and keeping a portfolio full of mediocre positions.

Just like picking all the flowers in your garden will leave you with a field of weeds.

Be quick to cut out the positions that don’t work. That will help you manage risk and it will also clear your mind to be able to think more objectively about your next investment opportunity.

Ironically, this principle works well in life also!

There are jobs, relationships, hobbies, and goals that deserve your best efforts and resources. And those that don’t!

Make sure you’re putting your time and effort into the winners!

Just some introspective thoughts as we wrap up another week of trading.

Enjoy the weekend!

Zach