Options for Rookies first appeared two years ago today. Thus, it's our blogging anniversary.
Today's post is #714, and whenever I see that number, it instantly brings to mind the name Babe Ruth. His career home run record (714) stood for more than four decades until broken by Hank Aaron on Apr 18, 1974.
As a tribute, this post is dedicated to Babe Ruth and how his career provides excellent trading advice for us. NOTE: This idea is not original with me. The Crosshairs Trader Blog, posted on this topic earlier this year.
In turn, that blog post was based on an excellent article written in 2002 and published by Credit Suisse/First Boston. The following quote comes from that source:
Principle: "The frequency of correctness does not matter; it is the magnitude of
correctness that matters."
Translation for traders: Babe Ruth struck out many times in his career. But he is remembered as one of the greatest hitters of all time. Those home runs contributed to Yankee victories far more often that his strikeouts resulted in losses.
As a trader, it is not how often you win that counts. When you consider your success or failure as a trader, the only number that matters is the number of dollars earned. Over a short time span, luck plays a big role. But as you trade longer, you discover that keeping losses (strikeouts) small – even when they occur more than 50% of the time – is the key to success. Collecting both small (singles) and large (extra base hits) wins makes you a winner.
Sure it feels good to have a string of winners and I always emphasize that feeling psychologically satisfied when trading is of value. But when you look at your results, you know it's far better to earn $100k when winning 40% of the time than to earn $60k with a 60% win percentage.
I'm not suggesting being reckless and consistently targeting home runs. In fact, there is no need to seek them. Some of your plays are going to work spectacularly well (yes, even when you adopt limited profit strategies). That's part of the game.
Your task, as risk manager, is to prevent the opposite – spectacular failures from occurring. You must not ignore risk when trading.
Skillfully managing risk, and minimizing the significance of your strikeouts, allows those home runs to play a big role in your profit/loss picture. If those big wins are accompanied by large losses, you are not likely to succeed.
Do not ignore the value of singles and sacrifice bunts (exiting a trade that has become too risky). Those are the bread and butter trades that feed your family. The home runs pay for the luxuries.