As traders we tend to easily remember all the giant profits trades, everytime our stop was hit and the market turned and ran in our favour without us. We rarely ever remember or talk about the times our stop was hit and the market fell some more.
Trading and investing is really a game of turning cash into an asset (long/short position) then back in cash. We typically look at a trade entered and a trade exit. We are either in a position or not. I say, we’re always in a position, remember cash itself is a position.
We only call it a trade when we turn cash into a position and the end of that trade ends when you turn the position back into cash. If we look at trading this way as a conversion of assets from one kind to another. We can safely say exiting a position is also taking a trade. How? Well let’s look at this concept a bit more.
When I’m going into a stock, I’m also implicitly short cash by the same amount I was long. When I exit the same position at profit or loss. I implicitly long cash and short the stock, even though I didn’t go and take a short trade. In other words I can express a short trade or idea by just staying in cash, meaning I’m short the stock long cash. The further and the longer the stock falls or stays in the range without me. The more profitable that trade is. Why? Because cash earns an interest not by very much but it does, secondly and most importantly the profit I gain is what I call an opportunity gain. Because I’m in cash instead of falling stock I have more in the pocket book and reserved my mental capital for the next opportunity. Being long a falling stock and implicitly short cash. Is a giant opportunity cost, and the market will let you run that bill for as long and as far as you wish.
Let’s look at some examples. I’m going to use my Anheuser-Busch InBev) trade as an example
Trade 1: Long Anheuser-Busch InBev short cash at R1022.24 Exit at R981.01 result R70.09 loss
Trade 2 (The implicit trade) Long cash short Anheuser-Busch InBev at R981.01 result? Let’s look at the chat below
So what is the profit here you ask? Assuming I didn’t take the second trade and exited the position at a small loss. The small R70 loss would have been a R225 loss today as I write after the close 4 August 2021 the stock closed R889.87. A loss 3X bigger. So my profit on the long cash short the stock at R981 is R155 in counting (R225 – R70) 2X the loss on the first explicit trade. That’s the hidden profit no one is talking about. I had no idea the stock would continue to fall. But I didn’t have to lose any more capital to find out if I would recover. Most importantly my account is R155 healthier than it would have been had I stayed with the position for any reason whatsoever. If the stock recovers I will be in a healthy position and take the opportunity. The risk is quite small for the reward.
Thinking of exiting a position especially a losing one as another asymmetric bet. Instead of just taking a loss, and also looking at these hidden profits. It makes it easier to take the loss while it’s still small. The most important rule of survival in the market. CUT YOUR LOSSES SHORT, or rather KEEP YOUR LOSSES SMALL.