The One Rule Traders Should Never Forget!

The other day I read one of those “Greatest Lessons from Investors” articles in WSJ. I seem to come across one every week, given the massive amount financial reading I do every. This one was no different -- basically recapping all the bromides familiar to us all. However, as my eyes glazed over the words, I stopped and found this passage on Jeffrey Gundlach the King of Bonds actually useful.

It was March 2008, and Jeffrey Gundlach was testing his nerve in a crisis.

Even assuming a rash of defaults and other bad news, debt investments priced at 65 cents on the dollar looked attractive. He began buying, though he knew there was a good chance markets would continue to drop.

“If fundamental value is compelling, you should keep buying,” he says. “It’s OK to take short-term losses.”

Mr. Gundlach was right—prices continued to fall for another full year, eventually hitting 45 cents on the dollar. One big client got nervous and withdrew money from his fund. Mr. Gundlach ran out of money and couldn’t buy more, locking in his cost basis.

By 2009 bonds started to recover as the Fed saved the world from the Second Great Depression and Gundlach’s trades started to turn profitable. Now he is recognized as the undisputed King of Bonds and everyone wants to give him all their savings to invest.

But stop for a second and consider something.

What if bonds went to 25 cents and stayed there until 2010? Gundlach would have gone from hero to zero and nobody would be hanging on his every word. He may have been forced out of business.

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So here is the lesson for us all. If you want to survive and thrive in trading -- never run out of money. In other words trade small. Its the one rule that trumps all others when it comes to what we do.

Boris Schlossberg

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