I've written a lot about the importance of keeping track of
your past trades and calculating key metrics such as batting
average and slugging percentage. I won't rehash all that
here, but I do want to touch on something that occurred to me
when reviewing a few of my trades this week.
Aside from all the customary statistical analysis, I also plot a
histogram of my trade results. I create a dozen or so columns on
the chart, each one measuring the number of trades that resulted
in X amount of profit (or loss).
One column in the middle might be any trade that lost less than,
say, $100, or made less than $300 (i.e., nearly breakeven).
The column to the right might convey how many trades made more
than $100, but less than $300; the next one on the right, from
$300 to $500. Accordingly, the left side of the chart would
categorize losing trades. An example below depicts 40
Glancing at this chart, you can see 10 trades in this batch were
closed out right around breakeven. Another eight were
closed out with small profits ($100 to $300). And from
there it spread out roughly evenly--a lessening amount of losers
and winners as the numbers got larger, though there was a minor
skew toward the right hand (profitable) side.
So far, the results resemble a standard bell curve--that is, most
results are around the middle, and the farther you get from the
middle in each direction, the fewer results you see.
But wait! There happens to be an out-of-sorts column way
out to the right hand side--there were three trades that garnered
more than $1,300 in profit. This is what's known as a "fat
tail" to the bell curve, and it's what I want to focus on.
Simply put, this fat tail is how a winning investor beats the
Any investing system that generally follows the mantra "cut
losses short, let winners run" probably will feature a
distribution curve similar to the chart above. While most
people picture a winning trader as constantly and consistently
churning out winners, the reality is that most successful systems
endure long periods of treading water, with just a few trades
responsible for most of the gains.
In this example, just three out of 40 trades resulted in big
money. (Note that the dollar amounts in the chart are just
examples; "big" is a relative term.) The other trades
basically canceled each other out!
What can we learn from this?
First and foremost, you shouldn't get discouraged if you have a
streak where you win one, then lose one, then win, then lose,
etc. Such action can be super frustrating, and it's
probably a good idea to back off when you see this. But be
sure not to get discouraged--realize that even the best traders
have these back-and-forth periods; they're perfectly normal.
Second, it re-emphasizes the value in cutting losses.
Why? Because if you let a few small losses (in this
example, say, $400) morph into bigger losers ($1,000 or more),
they'll eat into the benefit you get from those big
winners. In other words, you have to make sure your big
winners really count.
Third, you should be hesitant to tell a stock when it's gone "too
far." As you probably know, I think booking some partial
profits on the way up is a good idea, and there are times when a
profitable stock just doesn't have the get-up-and-go you're
looking for, so you can sell it on the way up, too. But if
you're booking small profits left and right for no reason, you'll
never be able to develop a bigger winner ... and consequently,
you'll have a hard time making money.
Lastly ... and something that few investors really think about
... is that having a system that is so skewed can actually be
very liberating. The reason is because you know that you're
only one good trade away from putting a boost in your results ...
or, if you're already doing well, from kicking things into
overdrive. Contrast that to systems that make very small
amounts of money frequently--but then lose a bunch all at
once. It can be depressing in that situation, knowing that
a huge grind is needed just to get back to where you started.
Anyway, the major point is really to know the ins-and-outs of the
methodology you're employing. That way, you'll know what is
"normal" for your system, giving you confidence to ride out some
tedious, back-and-forth periods and to shoot for those valuable
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For my stock idea today, I'm going with a small company with a
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off in February. I'm talking about
, which has been called the YouTube of China, but in reality,
it's more like a combination of a Netflix or Hulu (because it
offers generally professionally-made movies and shows) and
YouTube (because advertising is the main source of revenue).
The company just reported first-quarter earnings last Thursday
evening, and while the loss per share of six cents was a bit
better than expected, the real upside showed up in revenue, which
totaled $19.5 million, up 174% from the year before and well
above expectations. Triple-digit revenue growth has always
been one of my favorite fundamental criteria, and Youku.com had
140%-plus year-on-year growth in nine of the past 10 quarters.
The stock actually blasted off just as the market was topping in
mid-February--it rose nine out of 10 weeks, advancing from 30 to
70 during that time. Powerful! Then came the
correction, and it brought shares down to 54 last week, where
they found support at the 10-week moving average.
So YOKU is a great buy right here, correct? Not so
fast. Leading stocks are still generally under pressure, as
are many Chinese Internet-related stocks. I'm not advising
people to buy many things hand over fist. But YOKU is young
(it went public only last December), likely still under-owned
(just 128 mutual funds own a stake) and has a ton of growth ahead
It's small and speculative, but a small position around here,
with a stop around 52, could work out. At the very least,
we'd keep the stock on your watch list.
All the best,
Editor of Cabot Market Letter
Editor's Note: Mike Cintolo is VP of Investments for Cabot, as
well as editor of Cabot Market Letter, a Model Portfolio-based
newsletter of the best leading growth stocks in the market.
It's been over four years since Mike took over the Market Letter,
and during that time he's beaten the market by 13% annually (up a
total of 65% since then, compared to a loss of 6% for the S&P
500) thanks to top-notch stock picking and market
timing. If you want to own the top leaders in every
market cycle, be sure to give Cabot Market Letter a try by