Cut Your Losses and Let Your Profits Run

This paper tests the old adage and investment strategy "cut your losses and let your profits run" for randomly chosen portfolios comprised of large US stocks. We find that "cut your losses" 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 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. We demonstrate that the poor performance of the old 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. We further argue that investors are lucky that cut-your-losses is not strictly implemented by all investors as markets would frequently break down as a consequence.