The Generic, No-Voodoo Trading Process

I notice that in conversations with traders, they often think about entries, exits, and discrete trades with some sort of life-cycle.

But your P&L does not come from a trade.

A trade doesn’t change your P&L much, except for the commission and spread costs that you incur.

Your P&L comes from holding a risk position (a stock, crypto, etc), and then that position subsequently changes in value.

So you’re much better off focussing on what positions you want rather than when you enter and when you exit.

When you enter and exit doesn’t really matter. That’s just a swap between a cash balance and an asset.

What really matters is the exposures you’re holding and how they change.

Trading is about positions

Trades, at least in my mind, are not things with a life cycle that opens and closes; they’re just events that change my positions.

If I buy $100 worth of IBM stock, that simply shifts $100 out of my cash balance and into my IBM stock balance. I’ve just swapped some balances.

The P&L comes from the change in the value of the stock.

Let’s say I sell that IBM stock for $110. We can agree that I made $10 (ignoring costs).

But the P&L didn’t come from the buying and selling. It came from holding a position while the value of the stock changed.

The trade is relevant because it results in us having a position. But our P&L comes from holding that position while its value changes, not from the trade itself.

Our mission as traders, therefore, is to constantly (or at some acceptable frequency) look at the positions we have and compare them to the positions we want. And then to trade into those ideal positions, if they’re sufficiently different to what we currently have.

That means that there’s never any excuse for bag-holding. There’s no excuse for saying, “I’m only in this position because I’m already in it.”

If you wouldn’t buy a thing you’re holding right now, then you shouldn’t have it on (unless it’s sufficiently similar to something you would like to hold, and the costs of switching are greater than your difference in expected return – but that’s a story for another time).

Having a position on and putting it on is essentially the same thing (although the latter does have a small cost involved, which is worth considering, especially in less liquid assets) – because the thing that drives our P&L is the position, not the trade.

This seems a subtle point, but it’s worth engraving on your brain. Because without it, you end up with all sorts of voodoo beliefs like not realising losses or bagholding.

If a stock I hold decreases in value by $10, then that’s a $10 loss whether I’ve sold that position or not.

People will often say, “I don’t want to sell that, even though I don’t like it, and even though I wouldn’t buy it today.”

But the truth is, you’ve already made that loss! You’re already holding something that was once worth $100 and is now worth $90.

Pretending that you haven’t lost that $10 because you haven’t realised it is honestly little more than some emotional cope that is not going to help you one bit.

In fact, it’s going to hinder you because what remains of your capital will be tied up in positions that you don’t want!

One possible exception is when an asset is very illiquid, and selling it would mean that you realise a significant additional loss. But even then, you’d need to consider the best place to have your capital deployed.

Summary

To summarise, there’s never an excuse for holding a liquid position that you don’t like anymore.

As Euan Sinclair says, positions are not marriages. They are not things that need to be repaired. If you don’t like the one you’ve got, you can immediately change it to one that you like better.

This is the crux of trading.

You have some positions. Over time, some of them get bigger, some get smaller. Some of them you start to like more, some you like less, depending on your views of the future.

Your job as a trader is to compare these positions to the ones you ideally want and to trade towards them. You can fix things immediately and trivially by trading out of the things you don’t want and towards the ones you do want.

Sometimes, people are reluctant to do this because they want to make back losses on individual positions. But if you want to repair your P&L, putting on a better position is far more likely to help than just bag-holding an existing position that you don’t want anymore.

Let go of the mindset that has you white-knuckling and bag-holding unrealised losses. Instead, get into a more myopic, present-tense mindset where you focus on the difference between your existing and ideal positions.

No doubt this will feel jarring or annoying if I’ve labelled your thinking “voodoo”. But I hope you’ll let it percolate and think about it. Your P&L will thank you in the long run.