That rearview mirror really is 20/20. It’s the land of woulda, coulda, shoulda.
Too often we look at stocks we didn’t buy for whatever reason and get angry. But the real fault lies in not selling at the correct time. As Kenny Roger says:
“You gotta know when to hold ‘em. Know when to fold ‘em.”
We talk so much about when to buy and so little about when to sell. This overlooked side of the equation is just as responsible for your investment performance as the buy side, if not more.
Today I am going to share with you the four rules to selling at the right time, so you’ll know when to take a profit and when to cut your losses.
Rule #1: NEVER Move a Stop-Loss Further Away
How many times have you done this? Put in a stop-loss only to convince yourself later that the stock is going to come back for sure, so you move the stop-loss lower.
Then guess what happens? You get stopped out at a bigger loss.
I only enter trades with a good risk/reward ratio, and if the stock begins to drift toward my risk parameters I cannot alter those parameters. I pretend I’m at a roulette table. Once the dealer swipes their hand over the table, there are no more bets.
Moving my Stop-Loss deeper into the red would skew my risk/reward ratio severely. Not only would I be sabotaging my original trade, I’d be jeopardizing my next trade by taking away capital from my next stock idea. And remember, there are always other ideas. I swallow my pride, take the loss and quickly forget about it as I move on to the next attractive opportunity.
Rule #2: Play With the House’s Money
Don’t be afraid of these Stop-Loss orders. To the contrary, you should embrace them. I could even argue that most of your trades should get stopped out. Blasphemy, right? I know. But you’re looking at it the wrong way.
I move my Stop-Loss to breakeven as soon as possible. Now I’ve taken a trade that originally had a good risk/reward ratio and turned it into the perfect risk/reward ratio. Stock goes up, Stop-Loss at breakeven, my risk is zero and my reward is unlimited.
I am especially talking about high-beta names that move more than the stock market does. The increased volatility lends itself very well to this type of trading.
Rule #3: The Trend is Your Friend
You can chalk this one up right next to “Let the winners run” because it means the same thing. I never sell a stock that’s in an uptrend unless there is negative estimate revisions or bad news/event risk. If a stock is still above its 25 day moving average, then I don’t sell it. Doing so can keep me on the sidelines while the stock keeps on trucking.
I do my homework prior to entering a trade and I know areas of support and resistance where the trend is likely to change, reverse or slow. I keep an eye on these levels and I sell only after I have confirmation of a reversal. I won’t sell unless the downtrend has begun.
Too often investors are quick to take profits and hold on to losers forever. By understanding the trend, you can help yourself avoid this major pitfall of the individual investor.
Rule #4: Treat Every Day Like the First Day
I look at every day on every trade and I ask myself “Would I buy this today?”
If the answer is “No” I sell immediately. Each day I review where the areas of support and resistance are, where my stop-loss is placed and what the trend is telling me. If one variable in my winning stock formula is off, then I adapt my parameters to compensate or I exit the trade.
I use these four rules to tell me when to sell. Just like the buy side of the equation, this is not a perfect science. However, by using these rules I am able to tip the scales in my favor and give myself the highest likelihood of success.
Good Investing,
David
David Bartosiak is Zacks’ resident technical and momentum expert. He selects stocks and delivers daily commentary for our newly launched Zacks Momentum Trader.
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