The System – Cut your losses, let your wins run

A few weeks ago, I visited Vegas for the first time.

During the flight I listened to a program called “The Psychology of Investing” that had a pretty interesting concept.

The audience was given $100,000 of fake money each and asked to invest on 40 mock trades that the speaker called out. The speaker drew colored balls out of a bag to decide the payout 1x, 2x, 10x, -1x and -5x. The entire audience had the same 40 “trades”, and for each trade, decided how much of their capital they would risk. Less than 40% of the trades were winners.

At the end, some people walked out losing more than their investment while others made several millions. With the exact same 40 trades and being “right” less than half the time.

Thought provoking? Yep. A system of money management is more important than choosing trades. You don’t even have to be right all of the time as long as you are careful about how much you lose. Cut your losses and ride your gains.

I decided this was the magical answer and created my system for Vegas. I used a simple betting strategy, stick to Black on the roulette wheel. How much to bid was a little more complex though. I have a paper napkin from Vegas still saved with this magical formula.

Long story short, I converted $10 to $60 over the period of 2 hours – 500% returns. Of course I kept losing and winning, so it inched its way up. But the cool thing was, anytime I hit a winning streak I climbed up a lot. Anytime I hit a losing streak, I slid down a little.

Once I got back home, I decided to use the same system in the stock market. After Vegas where the odds are stacked against you, the stock market seems almost too easy. Winning streaks are easier to cash on and the odds (with a basic stock picking strategy) are higher than 50%.

I’ve been trading for 20 days so far, and am $600 ahead (in a range market with two losses already). Thats 5% returns in less than a month in spite of losses. Managed to find a couple of winners that crept up 20% in two weeks.