Cut Your Losses and Let Your Profits Run

This article tests the adage and investment strategy “cut your losses and let your profits run” for randomly chosen portfolios composed of large US stocks. It is found that any cut-your-losses strategy clearly underperforms the buy-and-hold strategy. The results hold for monthly, quarterly, and annual data and even for daily data around the 2008 Financial Crisis and the 2020 COVID-19 outbreak. Cutting losses during the 2008 crisis performs better than the benchmark for half of all portfolios but not consistently and not during the 2020 crisis. The article demonstrates that the poor performance of the adage is due to weak loser stocks (that do not strictly fall) and strong winner stocks (that do strictly rise), which implies that the best strategy is to let both losses and profits run. The results also question the relevance of the disposition effect as we do not find any evidence that holding losers too long is bad for investors. Furthermore, it is argued that investors are lucky that “cut your losses” is not strictly implemented by all investors, as markets would frequently break down as a consequence.