Preface

After a decade of trading, I still hesitate to claim that I have achieved enlightenment, but I can faintly see the path leading to long-term profitability. Lately, I have felt an urge to systematically summarize my ten years of investment experience, not only to improve myself but also to provide some insightful lessons for fellow investors.

In the first part, I will write a special topic titled "Paths That Lead Nowhere in Investing." These are all based on extensive personal practice and observations of friends who are also involved in investments. Some trading methods are impossible to succeed in the long run or extremely difficult to succeed with. Here, I acknowledge the mistakes I have made along these paths, hoping to prevent others from repeating them.

I will place a flag on these paths that says, "This Way Leads Nowhere." If you are currently attempting these investment methods and happen to come across this article, I hope you understand that running on the wrong path, even if you stop, is still a form of progress.

"This Way Leads Nowhere" —— Cut Off Profits, Let Losses Run

Let's take a look at two case studies:

Case Study 1: You predict that the price of a certain investment will rise, so you enter a long position. The market initially cooperates and starts to rise, allowing you to make substantial profits, let's say a profit of 1 million. However, after a period of increase, the market starts to retrace, and you notice that your account's profit goes from 1 million to 800,000, 600,000, 300,000...

You watch helplessly as your profits evaporate, and there's even a possibility of turning from profit to loss, ultimately hitting your stop-loss. A profitable trade not only fails to make money but ends up with a loss. This outcome undoubtedly leaves you full of regret, hating yourself for not taking the gains when you had the chance, for letting your greed expand. Why did you let the cooked duck fly away?

After reflecting on this painful experience, you make a change. "From now on, I will not be greedy in my trades; I will take profits when I see them." "I will never let a profitable trade turn into a loss" becomes your creed. So, whenever you enter a trade and start making profits, you become restless, ready to close the position at the slightest hint of trouble, claiming it's for "locking in gains."

Case Study 2: You enter a trade, and you have predefined your stop-loss level. Unexpectedly, the trade doesn't go well, and it quickly reaches your stop-loss level, leading you to exit the position. But then, right after you exit, the market immediately reverses and goes in the direction you initially anticipated, leaving you behind. This kind of situation has happened more than once. In hindsight, you wonder if you could have become a market winner if you had just held on a little longer.

In the above two case studies, they may seem fine on the surface, but based on my observations of investors around me, the majority of people lose money due to this: cutting profits short and allowing losses to run. Their flawed experiences lead them to repeatedly engage in trades where losses exceed gains.

Imagine a scenario where an investor consistently loses more than they gain. Would they be a long-term winner in the market? A rational analysis would quickly reveal the answer to this question. I can confidently assert that losing more than gaining is a common problem among failed investors. If you can address this issue and instead minimize losses while maximizing gains, you can essentially position yourself as a winner in the market.

Now, let's examine what went wrong in these two case studies. For example, is the popular advice of "not letting profitable positions turn into losses" correct or not? How should these two erroneous investment experiences be handled correctly?

Here, I will provide a straightforward analysis. In the case of Case Study 1, let's assume you entered a long position on December 7, 2015, at a price of $1,060, with an initial stop-loss level set at $1,040, and a target of $1,200. After entering this trade, the market did not perform favorably, and it remained around the breakeven point for a considerable period, even enduring periods of floating losses. If you continuously took profits during this period, you might have made small gains, but it can be said that taking profits prematurely was a mistake each time.

Finally, on January 6, 2016, gold finally broke out of its consolidation range, and your position started to generate profits. The first wave of the rally reached point A ($1,113, a profit of approximately $50), but then the market began to retrace, erasing most, if not all, of your profits. If you followed the principle of never exiting a trade with a loss, you should have exited by now. Once you exit, you bid farewell to the subsequent sharp rally in gold.

Please pay attention to the following key points:

Before proving you are wrong, you should hold your position. For example, during the original consolidation phase, you should only exit when gold falls below $1,040. Otherwise, you should stay in the position. At this point, both taking profits and stop-loss would be incorrect.

Only when the market breaks above the resistance level of the consolidation range should you consider moving your stop-loss level to the lower boundary of the range. Specifically, you can adjust the stop-loss level slightly below the trendline after gold retraces and touches the trendline. Of course, if the market keeps breaking above resistance, such as in the case of gold rising above $1,130, you should definitely not exit with a loss.

Knowing when to close your position is a crucial issue. As the saying goes, "buyers are apprentices, sellers are masters." It is not easy to solve this problem, but one thing is clear: trend investors must endure profit retracements and floating losses. Never rush to take profits just because you fear profit retracement. As for how to exit a position, in simple terms, the principle for trend investors is to exit only when the trend has ended, at least when there are clear topping signals from a technical standpoint or significant changes in the fundamental factors.

For many investors who are troubled by the situation described in case two, where the market immediately reverses after the stop-loss is triggered or returns above the stop-loss level shortly after, the underlying reason is actually quite simple: your stop-loss is flawed. More specifically, your stop-loss placement method is problematic, and the most common issue is setting the stop-loss too tight. For example, if you entered a long position at 1060, placing your stop-loss order at 1050. The correct way to set a stop-loss order is to position it slightly below a support level or above a resistance level. In the case of gold, if the previous low is at 1046, then your stop-loss order for a long position should be placed slightly below 1046.

Of course, there can be false breakouts, but the probability of such false breakouts is relatively low. Even if you get stopped out, overall, you have an advantage from a probability perspective. Stop-loss placement is a skillful art in itself. Not using stop-loss orders is not acceptable, as it leaves you vulnerable to a significant loss. However, haphazardly placing stop-loss orders is also not advisable, as it would be a slow form of self-sabotage.

To conclude, I would like to share a quote from Livermore:

"...study the overall conditions, hold your positions. I wait without impatience. I am unyielding in the face of setbacks, knowing they are only temporary. I once sold short 100,000 shares of stock, and as I anticipated, the price quickly rebounded. But I remained still, watching as a floating profit of $500,000 evaporated. I never considered covering my short position; I would sell it when the price rebounded because to do otherwise would mean losing my position. It is the big moves that make you big money..."