David Ricardo is often thought of as the most important economist since Adam Smith. We have him to thank for ideas such as the law of comparative advantage, and he advocated for things like free trade and sound money policies.

But what you may not know is that he was also one of the richest economists in history.

#-ad_banner-#Ricardo made his money as a broker and financial market speculator. But he owed most of his investing success to a single bet he made in 1815. In short, the prices on bonds that lent money to the British government during wartime were extremely depressed. Ricardo scooped up the bonds and when the outcome of the war was far from certain and later became a millionaire when Wellington defeated Napoleon at Waterloo.

But it’s not exactly the fortune Ricardo amassed or his economic theories that I want to bring to your attention. Rather, it’s one of the most famous sayings in all of trading history that is attributed to him:

“Cut short your losses; let your profits run on.”

Even though Ricardo said this back in the 1800s, it still holds true today. It may seem like an obvious piece of advice. After all, don’t we all want to maximize our gains and minimize our losses?

But it’s easier said than done. 

Consider a study from Dalbar, which found that the average individual investor makes a measly 2.6% each year.

One of the biggest factors behind such poor performance among individual investors is that emotion simply gets in the way. One of the foremost problems: Most investors sell their winners too soon and do nothing with their losers other than hope that they rebound. 

The authors Gary Belsky and Thomas Gilovich describe this problem in their excellent book on behavioral economics, “Why Smart People Make Big Money Mistakes and How To Correct Them”:

Ask yourself if you’ve ever sold a stock not because you thought it was finished rising, but because you wanted to ‘lock in profits.’ And ask yourself how many times you’ve held on to a losing stock or mutual fund because you were sure it would ‘come back.’

This phenomenon is called “loss aversion” in the field of behavioral economics. And according to researchers, it’s one of the single biggest deterrents to a winning portfolio. 

Let Your Winners Run
Ricardo’s idea of “letting your profits run on” is one of the earliest examples of momentum investing. It’s essentially saying that as long as momentum is in your favor, don’t get out.

For many investors, the idea of buying stocks with momentum seems counterintuitive. Most see a stock reaching new highs and tend to think that shares have already run their course and are due for a pullback. But this runs squarely against Ricardo’s advice, as well as what my colleague Jimmy Butts has proven with his Maximum Profit system. 

Take for example Jimmy’s trade with American Railcar (Nasdaq: ARII). As you can see in the chart below, the stock had steadily risen for months before being flagged as a “buy” by the system. But Jimmy and his readers bought, and the stock continued rising. 

It’s also worth noting that when the tide turned, the system issued a sell signal and Jimmy and his readers locked in a 62% gain in less than a year — before the stock went on to lose 66%.

Here’s the simple truth about successful trading I want you to remember: winners tend to continue winning and losers tend to continue losing. So if the selloff has you sitting on a 20% loss in your portfolio, then you should probably do yourself a favor and cut it. Sell now and don’t look back. Focus on your next idea. 

“Cut short your losses; let your profits run on.”

Note: I’ve mentioned Jimmy and his successful Maximum Profit system several times in the past few weeks. By following a simple set of buy and sell signals, Jimmy and his readers have been able to make gains of 39%… 46%… even 181% — all in less than 13 months.

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