Most traders and investors spend all of their time searching for the perfect stock to buy.
You're probably no different. . .
It doesn't matter what trading style you use. It doesn't matter what kinds of stocks you buy. Your investing goals don't matter a bit either. No matter what, I'm willing to bet that you spend close to 90% of your time buying or waiting to buy.
Yet you completely neglect the work that goes into selling your positions.
Think of all of the "bad sells" you have made since you first dipped your toe in the market. What if you could go back and correct all of your mistakes? Imagine how much money you could have saved if you had concentrated your efforts on selling at the right time…
Reverse your thinking– and put selling first– and you'll fix most of your problems. Just remember, selling a stock is your most important duty as a trader. If you put as much time and effort into each one of your sells as you do your buys, you will instantly improve your trading returns.
First, you need to change your thinking. Quit obsessing over your buying process. Allow the market to lead you to trades. Pull the trigger when opportunities arise.
It probably feels counter-intuitive– but buying is the easy part. Last week, more than 130 stocks that trade on a major U.S. exchange posted gains 5% or more. There was nothing inherently special about Tuesday's market action either. In fact, the S&P finished the day near breakeven. Yet the market gave you plenty of trading option. Any one of these stocks with a favorable risk-reward set-up could have triggered a solid trade.
However, the real work begins after you own the stock. But if you follow my three tips for successful sells, you will have a much better chance at booking consistent trading profits.
1. Set Your Trading Rules
You're not just buying random stocks. You have specific rules you follow for every single buy.
But you should also have specific rules for selling. And you must make these rules before you enter any new trade. Before you buy a stock, you have to figure out your stop loss. Then you have to stick with it.
It's important to calculate your stop loss before you enter a trade to prevent any self-sabotage. Once you own a stock, it's all too easy to let your emotions convince you to hang on to a losing position. You'll move your stop loss lower, telling yourself that the stock will soon rebound. But what you'll find is that your emotional decisions will saddle you with twice as many losers as winners.
Set your trade parameters before your money is on the line. It simplifies the entire selling process.
2. Take Profits to Clear Your Mind
First, you have to take care of your losers. But what about trades that quickly move in your favor?
If a trade shows you fast gains, the best action to take is to sell half of your position. Taking early profits will help you make better decisions when it comes time to get out of a stock.
Here's a quick example:
Let's say you buy a stock that's breaking out and you find yourself up 8% in just a couple of days. You think the stock is headed even higher, but you decide to lock in half of your profits. After you sell half your position, the market moves against you. Your remaining position begins to move sharply lower.
Remember, you already booked profits on this trade. So your decision-making process isn't crippled by any doubts or unreasonable expectations. You booked your profits, so following your original trading plan and honoring your stop loss is that much easier.
3. Remove Your Bias
Still, unexpected events can cause you to make bad decisions. Your convictions and biases can be your worst enemy when it comes time to let go of a losing position. That's why it's so important to stay focused and objective when a stock flashes a sell signal.
The market is never going to react exactly as you expect. Don't make a bad situation worse by trying to rationalize the market's behavior.
Take this note I received from a reader:
"I don't quite understand why Great Basin Gold's stock price has suddenly fallen off a cliff after their earnings report. . .60% off is not comprehensible."
Here's a perfect example of expectations clashing with the reality of the market. I'm almost positive that a 60% haircut on a mediocre earnings report was probably an overreaction. However, this information should not alter your trading plan. Do not let unexpected news freeze your ability to sell. Stay alert, honor your stops, and move on to your next idea.
When dealing with big loss, it's easy to rationalize holding on to the position. You'll think that the stock has to recover, at least a little bit. But the market doesn't play by your rules. Hanging on to a stock that's just posted a sharp loss is never a good plan. It will probably continue to move much lower.
One Final Thought. . .
If you're ever unsure about a stock you own, ask yourself this question:
Would I buy this stock right now?
If you would not buy the stock under its current circumstances, sell your position and move on. Putting yourself in the shoes of a potential buyer (as opposed to a hopeful stock owner) will give you a clearer picture of all of the possible outcomes.
Greg Guenthner, CMT