Line Your Own Pockets

Michael: 00:00

Okay, everyone. Welcome back to another episode of Line Your Own Pockets. We got a good one today. I know Dave's really excited. I think this is something that I remember, Dave being passionate about way back when I was training ideas, like, 5 years ago.

Michael: 00:14

I remember. I think you wrote an article about this. Why don't you tell people what we're gonna be chatting about?

Dave: 00:18

So we're gonna talk about partial profits, taking partial profits. And, essentially so somebody on my newsletter brought this up to me. Name was Maxwell Griffiths. He gave me permission to use his name here.

Michael: 00:34

Mhmm.

Dave: 00:35

But he went back in my archive and found this article that I wrote for the newsletter years ago. It's one of my most popular articles, and I I could tell it touched a nerve. And it's on, basically, how partial profits aren't all they're cut out to be. And, in fact, I just wrote I have a column in the technical analysis of stocks and commodities magazine, monthly column, and I actually just wrote about this topic, so it sort of freshened my mind. It's like, hey.

Dave: 01:04

Let's bring that stuff as a topic because I think it's a good one. Mhmm. There's there's so much we were talking about just before we started recording. Yeah. There's so much, basically, BS that people say that's just not true.

Dave: 01:22

And advice you hear, it's kinda crazy. I mean, it seems like there's a whole lot of people that know how to talk about trading, but don't really trade. And this is a prime example of advice you hear. Oh, why don't you you know, you got a profit. What should I do?

Dave: 01:41

Oh, well, why don't you take half off, and that's like this beautiful compromise. You don't wanna lose too much of the profit in case it comes back and hits your stop. So it it we'll get more into it, but that that's the topic for today. What do you think, Michael?

Michael: 02:02

Yeah. And I I think the the big thing is how just much it's regurgitating. Right? How how much it's out there of, hey. Yeah.

Michael: 02:10

I don't know what to do. And and I always say, I think the profit taking part, the, you know, the exit for profit is the hardest part of trading, because you'll never be good at it. You'll never there's no outcome that will make the human mind satisfied. Right? It's because if I sell here and the thing rips, I I am kicking myself because it or if I wait for it to come down a bunch and then I sell on some sort of trailing stop, I'm also mad.

Michael: 02:36

So it's one of those you you're always looking for the least wrong thing to do, and talking in large numbers and everything is mathematically right, but it doesn't feel good. So I think this that's probably where this advice came from is it's just the thing that just makes you feel kinda more warm and fuzzy inside, and people need that ability and need they need something to hold on for more. But if you wanna hold on for more, then wouldn't it have been nice to have double the position if you're holding on for more as opposed to half? Right? Yeah.

Michael: 03:08

For sure. It's it's one of those things where, yeah, there's the advice that's mathematically correct, and there's the advice that makes people feel good. And I always struggle on which of those is right. And it becomes an interesting thing where we all wanna think that we're robots, and we can just follow the the the advice that's absolutely mathematically correct. But I wonder if it's one of those things like, diet, where, you know, I could tell you chicken, broccoli, and brown rice, and then this amount of carbohydrates and fats and proteins, blah blah.

Michael: 03:38

But if you're not gonna do it, then wouldn't it have been better to say, hey. Have a cheat day once in a while even though it's probably not the best thing for you. Right? So I don't know. Where do you stand on the even if it's not correct, if it if you cannot physically, like, make yourself hold not do it, is it okay just to to break the rules every now and then?

Dave: 04:00

Yeah. So let's let's back up just a bit to explain exactly what we mean here. So if you're taking a partial profit, you're leaving money on the table. I mean, there's mathematically, there's no question about it. And if you're if you have a question about that, just go do a back test.

Dave: 04:18

Do a back test, and instead of using a target order that you're normally using, do one where you take half off partway to that target.

Michael: 04:28

Mhmm.

Dave: 04:29

See what the numbers do. I mean, mathematically, by definition, if you put that rule in place, you're never gonna get the you're never gonna achieve the full target level at your full size. Right. So it's really easy to see, and and I put a a nice chart in the article about this. The the regular one goes up really high, and then the the one with the partial profits is just plain as day less than that.

Dave: 04:58

Just Yeah. Very consistent less than that. So Well but

Michael: 05:02

when you be trading in some respects, win rate for, for profitability. Right? So if I'm taking profits on some of the position halfway through, I'm going to lose the overall expected profit on a trade, but aren't I gonna gain some back in win rate by kind of, you know, taking that a little bit? Just like when you're when you're back testing and you're you're dealing with a target. Right?

Michael: 05:28

The higher the target, the more you'll make when you're right, but the less often you'll hit that target and vice versa. So, right, isn't there some kind of math games that you could play there to, like, make yourself feel a little better?

Dave: 05:40

Of course. Yeah. What you're trading off is basically psychological comfort. And I'm not saying that everybody should trade like a robot and you should ignore psychological comfort. Psychological comfort is an important part of trading.

Dave: 05:54

And if that's gonna keep you in the game longer, even if it's not not mathematically optimal, I think that's totally fine. What I think people don't do, though, is they don't recognize that there's a trade off, and they think this is great advice from some guru they hear about. Yep. And there's many, many gurus. You and I know several of them that say this repeatedly.

Michael: 06:19

Mhmm.

Dave: 06:21

And it's just not true. It's it's there's a trade off there that the gurus sort of gloss over and don't recognize. And there's a and the trade off is significant. I mean, do the numbers. It's significant.

Dave: 06:34

So it's fine to make the trade off, but at least know you're making a trade off and what you're you know, what the benefit is and the cost.

Michael: 06:43

Well and I think something that we'll also agree in is that if if it's part of your test, then then do it. Right? Because it I I know people out there who have systems, and the systems are specifically designed for, right, I'm going to use, a target for some of this, and I'm gonna use a trailing stop for some of this. And they find and they're doing that to kind of tweak that difference between absolute profit and win rate in order to keep the system stable overall. So I think that's another thing.

Michael: 07:12

Again, correct me if I'm wrong, but if this is something that is part of the system and it's been tested and it's been optimized and all of that, then, yeah, you can ignore it. But I think what we're trying to push back on is just the, the brain dead advice of take move your stop to break even, which I think we can talk about in a second. I think it's even more harmful, but move your stop to break even and sell half, which just seems to be just kind of regurgitated just over and over and over again in every intro kind of thing. And again, I again, I think it's not out of malice. I think it's just out of comfort, and there are some people that probably trade their whole lives that way, because of that comfort, and they do okay.

Michael: 07:52

But, yeah, they're missing out on the fact of of what if. Right? Well, you know, and that's the the math you should always do is what if I did this differently? What if I held all the time until my target?

Dave: 08:04

Yeah. So you hit it spot on there when you said you're trading profit for win rate. And that can be fine, but you're probably not traders should not be optimizing solely on win rate. I mean, I think we can agree on that. And, but you should be taking that into account.

Dave: 08:26

So it's it's something that I I think you hear it so often because it sounds so good. It sounds tantalizingly good. You know? Hey. You're playing with house money at this point.

Dave: 08:42

You know, you you've moved your stop up. If it gets hit, you're gonna still make a profit. Yeah. It's so it's I know it resonates with beginning traders, which is, I think, why we hear it so much. It's sorta like this concept in, political thought called, the social desirability bias.

Dave: 09:05

This was made popular by an economist named Brian Kaplan. We'll put some links in the show notes. But the idea is, politicians, both sides of the eye all sides of the eye, nobody is, any better at in any other with this. Mhmm. They're gonna take a position that is generally popular but not necessarily true.

Dave: 09:32

They're gonna on the margins, they're gonna be taking popular positions that aren't necessarily true. Like, the classic example is if you look at if you look at the popularity of rent control, very popular among the public. If you do the same poll among economists, rent control is, like, overwhelmingly a terrible thing.

Michael: 09:57

Mhmm.

Dave: 09:57

So the experts that are paid to know how rent control actually works are dead set against it. But you would find politicians, they keep keep talking about rent control because it's popular. I think it's the same thing with these types of trading. Yeah. And I think trading advice.

Michael: 10:19

I I think even a better example there to to hit your point home is is nuclear and how everyone switched on a dime seemingly one day is right. In nuclear, you have the the hippies protesting that this was so bad and everything for the environment, and then just it seemed like one day, like, last year, everyone just flipped and said, oh, well, it's green. It proves a lot of energy. It's always on. It's fantastic.

Michael: 10:40

So you're right. It's it's people will, I think it's it's more of the the going against the herd and sometimes how hard that is. Right? When it comes to this, if you started trading and your mentor that you knew that was making a lot of money did this. And then, you know, everywhere you looked and every other successful trader you talk to, they're also doing the same thing.

Michael: 11:03

You're like, okay. Well, this must be the way to do it. And I think it comes, not necessarily naturally to people to say to question that, to go through, and I'm gonna have to question that. But like you mentioned, run the data. Right?

Michael: 11:16

And then and that will tell you one way or another, and that should be the way in kind of every piece of advice that you hear. I you know, I I'd say take a look at it. Right? We it's it's a different world now maybe than when that person started trading. Or, again, they found a style that worked for them, and they just got comfortable in it, and they continue to do it.

Michael: 11:36

Maybe, you know, that's fine. They make money. But, again, our argument is that person should even still be questioning. Right? What if I what if I did it this way?

Michael: 11:45

But, yeah, I think that there's a very hard dynamic. Again, especially if somebody is giving you education and they're giving you attention on your trading and they tell you to do something some way and you know that person is successful, it becomes, yeah, very hard to kinda break that mold and say, okay. Well, I'm gonna I'm gonna take the good stuff that you gave me, but this other thing I'm gonna what's the whole what's the saying? Trust but verify. Right?

Michael: 12:09

And I'm gonna test everything and the stuff that you're saying that makes sense, I'm gonna keep. And the stuff that you're saying that doesn't, I'm I'm gonna avoid, ignore.

Dave: 12:17

Yeah. I mean, that's why they say on here multiple times, backtesting is a superpower. It's Yep. It's your antidote against all this BS you see everywhere. If somebody says something, gives you what sounds like a good idea, hey.

Dave: 12:31

Let's run the back test and see and see for yourself. It may be it may be certain cases where that's the right thing to do, but it might not may not apply to you or any of your models. So, yeah, it's it's great to be able to to do that. One point about you know, people sometimes read this article and think that I am a 100% against taking partial profits, and that that's not true. So there are, there's a couple examples where I think it is actually worth doing.

Dave: 13:09

The the the first point I wanna make is if you find yourself wanting to take a partial profit often, then what I would say is there's a good possibility you're probably trading with too much size than you're ready for. Because you're a little scared when you've got a big profit. You don't want that to turn into a loss. You're probably trading with too much size. So that's one question to ask yourself if this is coming up a lot.

Dave: 13:37

If you're not able to hold all the way to the target because you don't want the pain of it have then then maybe you're trading with too much size. That's that's something to think about.

Michael: 13:47

Yeah. I'd say too much size. I'd also say maybe, maybe new to success, I think would be another thing too. I I know and I I still have it too when I'm coming out of a drawdown that more, more aggressive urge to try to get out of positions, a little bit more aggressively because you just want the feeling of, I'm gonna draw down things are no fun. You just kinda want that feeling to more or less go away.

Michael: 14:12

So that might be part of it too, but I do think it's it's one of those all purely psychological things where, right, you have to ask yourself what is it that's that's telling you to do this. Now, maybe it's that your win rate is too low for for what it is that you're able to deal with. Now, again, I agree with Dave that you don't wanna optimize based off win rate. I think, again, if you look at the turtle traders, if you look at some of the most successful traders in the world, they have sub 50 50, sometimes 30% win rates, on some of their systems. But, again, like the diet example, if you can't physically do that, then, yeah, it may be that.

Michael: 14:47

So I'd say, yes, too big or, again, you're just too new to, you're too new to success, or you're coming down from a drawdown, or there's some something that's psychologically, pushing you to saying, I don't I kinda don't believe that I'm gonna make money off this, if if that makes sense, where, you're you're trying to, you're trying to feel comfortable as opposed to, you know, there there's a pain that's happening somewhere in your body, and you're trying to make that pain go away. Yeah. Right. That's

Dave: 15:17

So so the the knowing that people do this when they're trading with too much size, they do it more often when they're trading with too much size

Michael: 15:26

Yep.

Dave: 15:27

I actually have found a way to use that as a recommendation in some cases. So there there's one situation where I will suggest taking partial profits or having a plan for it, and that is when the trader is trying to increase their size, and they're having trouble doing that. Mhmm. One way to get accustomed to the bigger size that you wanna take is to allow yourself for a temporary period of time to take some partial profits. That can help you get to that next level in a way that's not, you know, that's not so harsh.

Dave: 16:07

It'll help you ease into that larger size that you wanna, that you're trying to achieve.

Michael: 16:13

Well and I I think this is also a, a lesson too first, you know, something that we talk about a lot about not being at your screen. Right? Letting automation do as much as possible because, if you're not seeing that, then it can't hurt as bad. Right? It's one of those if if you set out your orders, if you have your system trading for you, and and you're letting it work, and you're working on something else, or or you're doing something that you're not focusing on it, then all of a sudden you don't see that big unrealized gain.

Michael: 16:42

It's, you know, the more analog example that I have back from, trading prop back when I did this way back in the day is people would just put literal sticky notes on their screen over their profit amounts. And the idea was to try to just shut that out entirely and trade the chart. So they would, yeah, put tape or or whatever and then pull that off on the end of the day and see how they actually did. And I think that was a fine way to do it in a world without automation, but now that you can automate your your systems a little bit better is find a way that you can just, you know, take your trades and and just shut it down and look at it later because I think that would help with a lot of it too. Right?

Michael: 17:22

Where you have your you know, if you're not seeing it, then it can't cause that kind of psychological pain.

Dave: 17:29

Yeah. So that it's funny you mentioned that because just the other week, I was, so so I'm trying to this one particular system, I'm trying to trade it with more size, and I am a cyclist. There's a there's a ride during the trading day on Wednesdays that I really like to do. It's really fast ride. And, I found myself not wanting to do that ride because I wanted to keep an eye on these positions, and I didn't want you know, I wanted to be there.

Dave: 18:01

And that made me think that, okay. I'm probably I I need to be able to do this right, and and I'm trading with too much size for the way I'm comfortable with this particular strategy right now. Yeah. So that's gonna be my barometer. Can I go for a, you know, 50 mile ride in the middle of the day and have my system continue to take trades for me?

Dave: 18:26

If I'm comfortable doing that, that's good. If I'm not comfortable, then it needs some work. I need to either reduce size or need to do more research to be able to get to that the the size I need to be able to trade and still do my bike ride.

Michael: 18:39

Yeah. Well and or maybe, right, get a slower buildup. Right? And and, speaking of that, would you for someone out there who's really addicted to the the profit taking, would, a methadone or a way to kinda get off that juice, would would you kinda recommend maybe instead of taking half off for a while, maybe take a 3rd off and see what that does to your trading, and then maybe move that 3rd to a quarter, and maybe move that quarter. Right?

Michael: 19:06

So do a 5th and, you know, reduce it that way, or do you just say, hey. Even if you've been doing this, run the tests. If the numbers say that you should you should be doing it all, just just do it all. Right? I'm I'm more I think I'm a little bit nicer, so I'd probably say, hey, you know, just work your way out of a bad habit over time.

Dave: 19:25

Yeah. Yeah. I think there are these cliffs that people have to mentally get over. And, you know, you imagine trying to climb a mountain. It's a lot easier if it's less steep and longer than if it's a huge cliff you have to do rock climb up.

Dave: 19:42

So, yeah, anytime you can reduce a cliff into steps, I think that's a good idea. I mean, as long as you as long as you know the the the costs and the benefits of what you're doing and that you have a plan for getting there. A lot of times, I will do the same thing with with, sizing for people. So when people are trying to increase their size, I, I will often you know, they wanna go from x to 10 x right now because they see how well the strategy is doing. They see they know they have an edge.

Dave: 20:19

You know, they're they're the the traders I'm I work with, you know, we work to come up with, I help their workflow to come up with strategies much more quickly than they're used to. So they're often at the point where they're like, okay. Let's scale the crap out of this thing. And I'm always like, well, let's take a step back. Set a goal for yourself in a month, 2 months, some period of time where you want to get to that that new level.

Dave: 20:47

Don't do it overnight, but have a plan for getting there. Have some milestones that you need to achieve before you'll increase the size. The big problem we could do a whole episode on this. The big problem is they increase their size. They've had some success.

Dave: 21:02

They increase their size too quickly, and the equity curve drops below 0 even though the system is nor you know, per performing perfectly normally. Mhmm. That's emotionally very difficult, and it's the the thing you should try to avoid when you're increasing size.

Michael: 21:18

Yeah. And I I I think that, you know, it'll have a lot to do with the the mental ability of someone to either increase size or not. And the beauty, again, of of what we do with trading is that that you can take any number of shares. So you can you can turn that dial of how much you want to increase size up or down very, very granularly. The the question is, right, how much is too little?

Michael: 21:44

It's a good weight lifting analogy would be. Right? So say you go, you know, you're benching 200 on the bench. Does it matter if you add another pound? Right?

Michael: 21:54

It's probably not. I wouldn't classify that as you're increasing the amount of weight you're lifting. So you have to find an increment that is enough that warrants even putting another bit of weight on it. It it it warrants your time and energy of increasing size, but not you don't wanna go right from that 200 to 400 because you'll die. Right?

Michael: 22:14

So, yeah, it it's finding that middle ground. I think that's as much you know, we we always talk about areas that you add discretion into systematic trading, and I I think that's a huge one is is what how much can I do before things get kinda too bad, kinda one way or another on on my trading? Yeah. I think that's a whole other episode on on how to increase and and, you know, and how much and what ways and in in that kind of thing. But, yeah, I think it's it's one of those if you're scared to risk an extra $50 on every given trade.

Michael: 22:47

Well, you know, risking extra dollar on every trade is probably too little, but just sit and try to find that middle ground that makes the most sense to you. Right? The difference between 50 and I mean, split the difference 25 or 10. But, yeah, just understand that I've been exactly where you were talking about before, Dave, where, you know, everything looks like it's doing fantastically, and then all of a sudden, I I get a little bit too ahead of my skis, and I double my size on the next 2 or 3 trades come along and and wipe you out, and then you go back down to the low side. Right?

Michael: 23:17

And that's not right either. Right? It should've been some sort of middle ground between the 2 of those.

Dave: 23:22

Yeah. It's also hard to see that. If you don't have if you don't have a really good journaling process and a really good workflow, you can look back at that and assume this is that the system is broken. Mhmm. But you've really only changed your size too drastically, and your your result equity curve looks terrible even those prefer working perfectly normally.

Dave: 23:48

So Yeah. Yeah. There are a lot of issues there, well, I'm sure we'll go over in another, episode. Let let's let's go back to Maxwell's original, email to me about this. So he said, okay.

Dave: 24:03

I read this article. I'm pretty sure I'm on board with this idea. But doesn't that mean that if we know that taking partial profits is not mathematically optimal, doesn't that mean that moving your stop to breakeven or at some point during the lifetime of a trade is mathematically optimal? So, Michael, what do you what do what do you think?

Michael: 24:31

Well, I think the the answer is gonna be the same as when it comes to position sizing. It's just be tested. Right? You should be able to test that through. For me, I especially as someone who trades long term, I have a bunch of systems that use some amount of trailing stops.

Michael: 24:47

Right? Different trailing stops for different systems. So naturally, they're gonna move that stop to break even at some point, in the trade, but I think it's the same kind of issue with the same type of advice of just saying, hey, you move your stop to break even. It it's and it's done for the same reason. It's that pain reduction of you take a big sigh and you say, I can't I can't, I can't lose money anymore.

Michael: 25:10

Great. And then that frees up whatever part of your brain to to continue doing. So I to be honest, I think it's probably just as harmful even if not more harmful just to do willy nilly as as partial profit taking. Again, unless it's part of a trailing stop system that you kinda already have in place, and then which case just kind of ignore what I said.

Dave: 25:30

Yeah. I think it's I'm not sure if it's worse than taking partial profits or better, but it's still a mistake. And it's it's very clear when you go back and look at the data that it's basically the same thing on the other side. You're trading profits for win rate. Right.

Dave: 25:51

And, and the other thing is the stop distance is usually gonna be a lot, smaller than the target distance. So you end up making a smaller difference when you move your stop to break even. So the the gain you're getting there is just not really that great anyway. So it's, again, you're optimizing for win rate is can be psychologically comforting, but it's not typically what you wanna do.

Michael: 26:31

No. And, you know, I think kind of the the key or or way to kind of talk about with all of this is that if you haven't tested it, then then it's just not what you wanna do. Right? You know, I I could certainly see a system in which, you know, a a trailing stop becomes so aggressive so quickly that it it is essentially the same as moving it to break even very quickly. And I I could see a world where a system like that does work, but, you know, I would need to see that world.

Michael: 27:02

I need to see those tests to say, this is what leaving a stop alone and then using something like a time stop. I know it's something that that's big that you do as a day trader or when it comes to, you know, looking at the, the times or, you know, some sort of trailing stop or moving average or or something like that. The just I don't know. It's almost just it seems like it's too crude just to say to move the stop to break even, because that's a pretty arbitrary price that you've just chose to move a stop to. And it's like, why why there and why that price versus literally any other price.

Michael: 27:37

So I think if you want to use a trailing stop system, then then use it. Just make it something that makes some sense for for what it is you're doing. Again, a moving average, a piece are a bar by bar stop. There's a million different ways to do it. But, yeah, just don't make it an arbitrary this is the this is the level that my pain goes away, so, therefore, that's where I'm gonna put a stop.

Michael: 28:00

That makes no sense to me at all.

Dave: 28:02

Yeah. Yeah. I think we've, I think that's anything else we wanna go over on this topic? I think we've, done a good job on it here.

Michael: 28:12

The the one thing that I did want to, just talk about and I think we've mentioned this book before, but is it is it best loser win? Yeah. Best losers best loser wins. And it's by, Tom Hogarth. I'm gonna butcher that name, but, it and it's kind of a book basically entirely on this topic.

Michael: 28:31

He he talks a lot about this about how, most humans trade sub optimally or trade poorly because they're doing this pain avoidance thing in different ways. And then he talks about the kind of the complete opposite. Now I think he goes, a little bit crazy on the other side where he talks about, you know, aggressively doubling or tripling or quadrupling into winning positions, which, again, if it's a strategy and it works for me, it's fantastic. But, yeah, it's just a great when I when you were talking about this, that was the first book that kinda stood up because it's like, you know, it's it's 58 pages of or no. It's, I think, a 258 or some pages of how basically, what we talked about and just example after example from from different people.

Michael: 29:13

So I think it's really just good book on the topic.

Dave: 29:16

Yeah. I mean, the sentiment sounds great. I I like the the catchy title because that is a lot of trading is becoming comfortable with being wrong.

Michael: 29:25

Yes. Yeah. And then that was the the basic idea is that, right, you're gonna have, you know, 2 groups of people, and then whoever is the best at kind of losing in positions, then that's the one that's gonna that's that's gonna do the best. Right? Is that, you have one that there's the very like, the things that we don't even really talk about because we assume most traders, I think, that are listening to this, are over, which is, you know, doubling down into awful positions or moving your stop loss or canceling your stop loss entirely or or holding a position, like, a day trade becomes an investment because it it's down a bunch for you.

Michael: 30:02

All those things, but, you know, on if you remove those, there's still all of the kind of psychological demons that got you there. And it was all about pain reduction anyway. So, you know, I guess that's a and a good exercise for everyone is, you know, we always talk about looking at your trading process and saying, where is it that I'm adding value, and where is it that I could just let a system do it for me? I can think another good exercise, is what am I doing to make myself feel good versus what am I doing to kinda optimally make money? And that might lead to some interesting outcomes if you sit and you do that thought experiment.

Michael: 30:40

Is there anything in your trading that you just do in order to kinda take the pressure off, and then that leads to we're not psychiatrists, but there's a whole road you wanna go down to where you probably wanna talk to some people that are different from us about for sure.

Dave: 30:55

Yeah. For sure.

Michael: 30:56

So, no, that was a good one. I like that was another, I think, more off the cusp one, and and we love that. We love emails. We love, you know, interacting and and doing, questions and kind of feedback that we got from it. So, keep that up.

Michael: 31:09

We appreciate it very much, and I am Michael Nas.

Dave: 31:13

And I'm Dave May. Hope to see you next week on Line Your Own Pockets.