Following the Crocodile Rule

2023-09-18
Summary:

Successful traders follow the crocodile rule, teaching us to leave early when losses expand and not expect to increase positions.

In the stock market, tracking failures is a common occurrence. When the banker flees the market, your profits may quickly turn into losses. In this situation, the wise choice is to acknowledge the failure and quickly take stop-loss measures. However, stopping losses has always been a hesitant issue for investors. Many investors are worried that if they stop losing and the market turns around, will they lose money? But if the loss is not stopped, the risk will continue to accumulate, which may lead to greater losses or even losing everything. This is precisely where retail investors find it most difficult to grasp the stock market.


It is said that the greatest traders in the world follow a principle called the crocodile rule. To become a successful trader, one must repeatedly train oneself to understand this principle. This principle is like: if a crocodile bites your foot, you will struggle desperately and only sink deeper. In this situation, the only way out is to give up one foot to save one's life. Applying this rule to the market means that if your trading errors result in losses and the losses continue to expand beyond your expectations, then perhaps you should leave the market as soon as possible instead of trying to average costs by adding positions. The purpose of stopping a loss is precisely to protect your principal, preferring to sacrifice some small profits rather than risk losing all of your principal.


In the actual trading process, many people may miss out on the opportunity to make money by stopping losses too early, but this will not cause significant losses to themselves. However, a wrong decision or not being willing to stop a loss can lead to serious losses or even loss of principal. Many investors get into trouble when stocks fall because they have the misconception that as long as they don't sell, they won't lose money. But in fact, during the process of stock decline, your account's market value is in a loss state, and if you hold it for too long, the loss will only continue to expand.


Usually, when the loss is between 10% and 25%, the risk is relatively small. When the loss is between 30% and 45%, it is already quite dangerous. And with a loss of over 50%, there is almost no chance of recovering the principal. Because when the loss is between 10% and 25%, you need a 13% to 48% increase in principal to make up for the loss. When the loss is between 30% and 45%, a 45% to 78% increase in principal is required. When losing 50%, the principal needs to be doubled. When the loss reaches 80%, a nearly four-fold increase in principal is required. This number is deeply alarming.


Stop-loss is the only feasible way to track failures. So how do you reasonably set a stop loss? Firstly, determine the stop-loss point based on one's own affordability. If you can withstand a loss of 10% or 20%, then when the loss reaches this level, do not hesitate, stop the loss decisively, and do not consider anything else. Once the loss is stopped, slowly consider the next strategy.


Disclaimer: This material is for general information purposes only and is not intended as (and should not be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by EBC or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.

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