Cut your losses and let profits run - Not so fast

 

There is the long-standing adage that a trader should cut his losses and let his profits run, a recent paper generated a different result. See "Cut your losses and let your profits run". 

Looking at equal-weighted portfolio, the authors test the idea that cutting losses will add value to a portfolio over a buy and hold. Similarly, the idea of letting your profits run versus taking some profits is tested. In both cases and in combination, the results find that you should not cut your losses based on a threshold nor should you form some threshold for taking profits. There is a upside momentum that may be stronger than downside momentum. Of course, this is a tested against the null that you should buy and hold versus a trading strategy. Nevertheless, this is consistent with the research that suggests that stop-losses do not protect downside risk. There is some value with cutting losses during a crisis, but that assumes an investor knows he is in a crisis. 

The approach taken with this research is simple, but it does provide some interesting food for thought on a view that has dominated much of investing. Do not cut losses. Let your profits run, and beware of the disposition effect. This work supports upside momentum and the fact that you should be aware of the disposition effect.