It's taken me a long time to slay my demon that made me sell stocks for small profits. Let's face it, selling makes us feel good, then move on to the next and repeat. The problem is these small gains don't do a whole lot for us. In any given year, how many of your trades actually impacted your bottom line. For me it wasn't that many. Most of my small gains were canceled out by small losses. It was the few large gains that made my year. But I saw I wasn't maximizing them. I was taking partial profits and worse, I was missing huge trends when I had nailed the entry perfectly.
So after much analysis, I realized that I needed to maximize my homeruns. To paraphrase Soros, its not how often you are wrong or right, its how much you make when your right. To that end, I need to adjust my approach to allow me to maximize my profits when I got it right.
It turns out the solution was pretty easy.
Here's the cure.
Stop caring. Stop caring about making a 8 to 20% gains. That's noise. If you are in a winning stock that will make 100% gain or more you have to be willing to let the stock come all the way in.
As Ray Dalio discusses in his "Principles," to be successful, you can't overweight the first order consequences at the expense of the expense of the second and third order consequences. Yet so often I see people bragging on twitter and stock twits about nailing a 20% gain. "Congrats to my followers" they say. -- By all means follow them to mediocrity.
If 20% is good enough to take profits, they will NEVER hit the 100% or more winner that has life changing potential. You can't have it both ways.
When it to Sell Your Stock:
- Stop loss - The max amount I'm willing to risk when taking a position on.
- Break Event / ITM Stop: After a stock moves in my favor, I usually move my stop to break even to slightly in the money. The logic being that If I'm stopped out at this point, it hasn't cost me anything and if the stock re-sets I can take another shot at it without having cut into my equity position.
- Failure to obtain an earnings cushion: Risk management first. If you don't have 10-20% gains (depending on the stock) you can't take it into earnings.
- Market conditions: If leading stocks are getting distributed, it doesn't matter what your stock looks like, get out of the pool. As Jesse Livermore wrote:
"An old broker once said to me: ‘If I am walking along a railroad track and I see a train coming toward me at sixty miles an hour, do I keep on walking on the ties? Friend, I sidestep. And I do not even pat myself on the back for being so wise and prudent.’"
- Psychological levels: buying tends to slow after runs at the major psychological price levels, 50, 100, 150, 200 etc... If you have gains, this can be a great place to sell into strength.
- Parabolic Character Change -- when the trend of a stock suddenly accelerates it is often at the end portion of its run. Sell into the strength:
Abnormal distribution: If selling hits your stock that is high volume and is out of character get out- ask questions later.
Great blog and an interesting post. I found you on Twitter, I commented your last tweet.
ReplyDeleteIt's interesting because I went from swing trading to all-or-nothing trend following. But it didn't work for me either and I'll tell you why.
It's true, almost every year will produce trends that finish parabolic like SQ. In 2013-2014 there was plenty of them and I had several 100% winners back then, the biggest of them ARWR +262%. If you caught 3-5 such winners every year, that would be enough, considering that you use decent risk management for failed trades. But the reality is that it is practically impossible to hit several big winning trades EVERY year. There is no way knowing in advance which stock will actually develop into a huge winner and which one will just stall at +50% and then reverse. You'd have to buy huge number of stocks to increase your statistical probability to catch some of those winners. And implications of this are not in your advantage: either you have to use small position sizes which decreases the effect of your big winners, or you can quickly get fully invested, or you simply make so many losses that winners get you to breakeven at best. With some bad luck you may have a very bad year (like myself in 2017).
I don't want you to think that I criticize your method or say it doesn't work. It's just my experience that conditions for home running trades do appear every now and then, but they are too rare to rely on. I still use trend following on my positions, but I scale out as trade develops. I think pretty much all professional traders scale out, regardless of time frame. Playing it all or nothing will probably get you into the perpetual boom and bust cycle, which is an inevitable step for all traders, but eventually we have to go past it into consistent profitability.
I'm very interested how you will do this year so please update your performance. I update mine on Twitter every week.
Thanks for the comment. I wouldn't describe my method as "all or nothing." Certainly, I want give myself the opportunity to stay in a stock that is trending, however, if it flashes a sell signal or the broad market does. I get out. You can't force an outcome that's not in the cards. As I noted, "If selling hits your stock that is high volume and is out of character get out- ask questions later."
DeleteMy trade management is much tighter than what people probably realize from twitter. Usually only 2-3% from initial entry (which means I need to buy differently than the crowd to have a chance). For that reason, I take very few traditional breakouts. Once I get up in a trade, I get my stop to even so it doesn't cost me anything if the trade fails.
I'll test a lot of positions in the manner I described. But the winners tend to show themselves and once a stock shows itself, I want to maximize my position in that stock. I've realized the most powerful weapon in a trader's arsenal to avoid the boom / bust cycle is the ability to stay in cash when the market is in the chop zone. It saves both your financial and mental capital.
Thanks for your reply. It's interesting, I also use a very tight stop, mostly below 2%. I have to time the entry perfectly, but I can risk very little for a decent position size. What's your win ratio? For a long time I've been struggling with it, but now I seem to get it around 30%. Scaling out helped a lot.
ReplyDeleteAnd how you're doing this year so far, in a chop zone?
This year + 42%, but 28% was this month.
Delete