Daily limits: the real reason you can’t get a cab on a rainy day

It’s an experience I’m sure we’ve all had … it’s pouring with rain, the taxi rank is empty, and any cab in sight already has passengers tucked up warm and dry inside it.

Of course, demand for taxis goes up when it’s raining, but there’s another factor affecting availability – DPLs, or daily profit limits … many drivers have hit their daily earnings goal because it’s been a busy day, and they’ve gone home early.

A study run a few years back on NYC taxi drivers found a clear pattern: when driving conditions meant there were plenty of fares, cab drivers would finish their shifts early; but if conditions were poor, and they struggled to find fares, they’d stick it out for longer, trying to eek a few more dollars out of the day.

It’s about patterns of behaviour, a worry that a bad day will set us off track, and a reward for a good day … it’s all very human. But in terms of efficiency and profitability, it’s deeply flawed.

If they stayed out longer on the rainy day, they’d make significantly more than they make in those extra hours on a day when fares were hard to come by.

Taxi drivers are quitting when they are ahead, and sticking when behind.

I’ve talked before about when we should quit and stick in terms of individual trades, but this is about whether daily profit goals and losses are a help or a hinderance.

What are DPLs and DLLs?

A daily profit limit (DPL) is a set goal for profits. When it’s hit, the trader pockets that money, and stops trading for the day. A daily loss limit (DLL), is a maximum loss you’ll accept for a day. When that loss level is hit – again, we stop trading for the day.

For day traders, this helps to avoid overtrading, taking away the temptation to keep chasing profits on a day when the markets just aren’t working for us, and the temptation to burn away profits made on a good day, but getting greedy for more.

You don’t have to be a day trader to use these limits. It’s very possible to apply weekly or monthly profit and drawdown limits.

As with many of the ‘rules’ we set ourselves, DPLs and DLLs help us to curb natural human tendencies which can often work against us.

But do DPLs and DLLs actually make us richer? Or poorer?

What we can learn about limits from the taxi rank

Clearly going home early on a rainy day when there are queues of people at the taxi rank is a bad policy for earning potential in a cab. But how accurate is this as an analogy of a ‘good’ day trading the markets?

‘Good’ trading conditions can be down to plain luck, just like catching a run of green traffic lights. But strategies may be suited to trends, or to range-bound prices, and it’s not unusual for markets to behave in ways that suit our trading style one day … and then to misbehave for us the next day.

But for a cab driver, staying out longer on a rainy day isn’t putting earnings made so far at risk in the same way that a trader is. Sure, there are running costs that’ll eat into earnings, but it’s unlikely to wipe out everything already made that day. For a trader, by contrast, it’s all too easy to have a great morning trading, only to give back all those profits (and more) before the end of the day.

The takeaways

• There are good days (weeks/months) and bad ones – markets and trading strategies just work that way. If we trade more in the good periods, and less in the bad ones, we can take advantage of that.
• Loss limits can stop us overtrading on bad days.
• Profit limits can stop us overtrading on good days.
• Overtrading is bad, but you’re more likely to lose if you overtrade on a bad day than on a good day.

As ever, we’re faced with a balancing act, between choosing a logical path, and choosing one that helps to even out our human flaws. If you find you’re getting into bad habits with overtrading, then these tools are there for you.

Personally, I don’t use a daily profit limit, but I will apply a daily drawdown limit – this is subtly different to a daily loss limit.

A daily drawdown limit is a pullback from my most recent high (which can include today).

So, let’s say my daily drawdown limit for my day trading strategy is 4% …

If I’ve made 2% in the morning, but then lost 4%, I’ll stop trading. I’m actually down 2% on the day, but I’ve suffered an 4% drawdown.

It’s what works for me. But I want to hear if you’re using DLLs and DPLs? And how you apply them? And I especially want to know your thoughts if you’re a taxi driver …

 

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