Got A Profit? Try This
The
market had a good day today. The Nasdaq put in a rare accumulation
day as it rose nicely on strong volume. There were also far more breakouts than
I have seen in quite a while. It will be interesting to see whether many of
today’s breakouts are able to succeed, or whether they will roll over as so many
in February did. I’m encouraged, but it will remain important to continue to
monitor price and volume action. One day doesn’t necessarily change everything,
but it does help.
In last Monday’s column I began
discussing profit taking. As a quick summary I established that there is no
profit taking system that would allow you to consistently take profits at the
very climax of a move. Therefore, profit-taking techniques fall into two
categories.
1)
You sell too early.
2)
You sell too late.
There are pros and cons to both
methods, and I discussed these in detail. The main jist of the conversation was
that selling too early made it easier to gets fills, you can reinvest your
capital quicker, and your account is be less prone to large drawdowns. Methods
that sell too late, on the other hand, typically are less prone to shakeouts,
and since they give the trade more room to pull back, have much greater home run
potential.
When traders begin to develop
their profit taking strategies, they need to choose a methodology that best fits
their personality. After weighing the pros and cons of each, traders need to
make a decision as to what mindset appeals to them more. For some people this
is fairly cut and dry. For many it is not so simple. Most traders are fully
discouraged by the cons of either method. They hate selling a stock only to see
it go on to great gains without them. They also hate giving back a large amount
of their potential profits and getting stopped out of a position long after it
has topped.
Yet every trader must take
profits. Otherwise you won’t be a trader much longer. So how do you take
profits without dwelling on the negative aspects of it?
You need to find a happy
medium.
Most of the trades I enter are
entered because I believe they have “home run†potential. Just a few really
good trades can make a huge difference in my profits. My goal is always to hold
them as long as the trend persists so that I don’t miss out on any huge gains.
That means I want to institute a “sell too late†philosophy.
Unfortunately, I was born with
an itchy trigger finger and voice in the back of my head that says, “Get out
while the gettin’s good! You’ve got a nice profit! Take it! You don’t want to
see it slip away! How much higher do you think this is going to move anyway?â€
By selling a portion too early
I am able to quiet this voice. Once I’m in a position where I have locked in a
profit and perhaps have a breakeven at worst trade, I find it much easier to
manage the rest of my position more loosely.
By understanding my own flaws I
am able to design a profit-taking methodology that fits my own personality.
With profitable trades I therefore have two basic goals:
1)
I want to sell a part of the position
too early.
2)
I want to sell the rest of the
position too late.
^next^
By building these methods into
my plan, the only reason I would have to be upset about the timing of my profit
taking decisions is if I deviated. I want to sell the first part of the
position before the ultimate peak, and I want to sell the second part of
the position after the ultimate peak. If I hold the first part too long
or get shaken out of the second part too early, then I’ve managed the trade
poorly.
Dave Landry does this with his
2-for-1 grandma money management. Dave takes ½ of the position off when the
stock reaches his profit target and then trails a stop on the rest. I don’t do
it exactly like Dave, but the premise is the same.
There is no magic number for
the percentage of one’s trade to sell to early rather than too late. It’s a
very personal thing. Some people strive to make a high percentage of small
profits. They like to see their account consistently trend higher. They might
be better served to take most of the trade off too early, and save the rest to
sell too late. Others may prefer to take a small amount off early to get the
trade in a better position and keep a larger percentage to sell to late.
What’s important is:
1)
You understand and accept the fact
that part of your profits will be taken too early.
2)
You understand and accept the fact
that the rest of your profits will be taken too late.
3)
You understand the pros and cons of
both.
4)
You choose a profit-taking strategy
that you can live with. If your personality clashes with your profit-taking
methodology, you will have a very difficult time adhering to it.
In an upcoming column I’ll
discuss considerations for adjusting your techniques based on the market
environment. .
Best of luck with your trading.
Rob