When do you sell a winning trade?
Think about this for a minute. Your answer could determine whether you succeed or fail. It really is that important.
Many people believe your entry is the most crucial part of a trade. They focus most of their attention on sifting through a mix of technical indicators, balance sheets, and broker reports.
But here’s the thing. You don’t make money when you buy — you make it when you sell. Yet, for many, selling is the weakest part of their strategy.
I’ve seen many traders come and go over the years. One of the leading reasons people fail are poor exits. Their mistake often comes down to one of two things:
- Cutting profitable trades too early; or
- Riding a stock up…then all the way back down.
A few members have sent in emails asking about trailing stops. Today’s update will focus on this key area. I’ll take some time to talk about Quant Trader’s exit strategy.
But first, let me tell you a story. It will help reinforce why exits matter so much.
From triumph to tears
I remember talking to a trader — let’s call him Ted — in early 2009. The GFC had hit mining stocks hard. Many were at rock-bottom prices.
Ted was telling me about a stock he was buying. The company was iron ore miner Atlas Iron [ASX:AGO]. It was trading about 70% below its boom-time high from the previous year.
The case for buying was compelling. I even bought a few shares for myself.
Ted was right — AGO took off. The shares rose by about 240% in two years.
I ran into Ted a few years later. We had a short initial banter. I then said, ‘how about Atlas Iron? You got that right!’
Ted just looked at the ground. I knew instantly he hadn’t sold. He rode the boom, and then held on for the bust.
AGO is currently trading at about 1 cent. Ted’s stock is practically worthless. Not having an exit strategy has been a disaster.
You might be wondering how I fared with Atlas. Well, I bought in at $1.35 in April 2009. The share price hit my trailing in December 2011, at $2.80. I did a bit better than doubling my money.
No, I didn’t get the high. I never do. That’s not how I trade.
I aim for the big chunk in the middle. That’s where I typically make the most money.
Quant Trader uses the same strategy. It’s all about maximising your chances of getting the big middle part of the trend.
Big trend trading
I’m going to show you a recent Quant Trader exit. It’s an excellent example of what’s possible when you ride a trend. This is why exit strategies matter…
This is the share price chart for Blackmores [ASX:BKL]. Quant Trader’s initial signal was at $33.93 on 23 December 2014. There were two additional signals at $39 and $44.
After 14 months, Blackmores finally hit its trailing stop last week. The $153.81 exit locks in respective gains of 353%, 294%, and 249%.
This looks like an easy trade at first glance. It’s a nice smooth upward trend. But these big sweeping moves can be deceptive. They mask the corrections along the way.
You see, Blackmores didn’t trade higher day after day. There were several pullbacks within the main trend. The four largest ones were 18%, 15%, 19%, and 22%.
Corrections have a habit of shaking traders out of their positions. They can leave you sitting on the sidelines watching your old shares soar. Your exit strategy can make all the difference.
Have another look at the chart. You’ll notice a red line that ratchets higher with the share price — that’s the trailing stock. It’s the point where Quant Trader exits the trade.
People sometimes tell me that the trailing stop is always late to sell. And they’re right. BKL peaked at $220.90. Quant Trader’s exit was 30% below this, at $153.81.
But do you know what? It’s often better to be a late seller than an early one. The very reason Quant Trader got a 353% gain is because it was slow to sell.
Letting a position run involves taking a risk. It means you have to accept that you’ll never sell at the high. Inevitably, you’re going to give back some of your gains.
There’s no way around this if you want to catch big trends. The 100%-plus winners — like Blackmores — are the reward for accepting that risk.
Some members have suggested using a tighter trailing stop. They believe this would get them out closer to the top. This sounds good in theory, but it’s rarely that simple.
Setting the trailing stop too close creates a new problem. It will typically result in a stock hitting its exit point sooner. This is another way many traders end up selling early.
I’ll give you an example. Let’s say we set the trailing stop for BKL at 10%. This means the exit point will always be 10% below the most recent high. What do you think will happen?
Have a look at this next chart…
Compare this to the first chart — it’s a very different result. A 10% exit stop results in an early exit. The system attempts two additional entries, but both hit their exits before getting too far.
Tighter stops are more in keeping with shorter term strategies. Quant Trader is targeting medium term trends. And these typically need more room to move.
It’s really very simple. If you want to ride big trends, you need to give them breathing space.
There’s a reason so few people capture these big moves. It’s because they try to hang onto every dollar of profit. They don’t want to risk giving anything back.
But that’s a mistake in my view. You have to be willing to hand back some profit. That’s how you stay on the stocks that double, treble, or more.
The trailing stop also makes sure you don’t end up like my friend Ted. Imagine riding a trade like BKL all the way back down. Then again, let’s not!
Medium term trend following is all about running winners. Sometimes, small winners will become losers. But the big winners typically pay for these many times over.
Until next week,
For The Daily Reckoning
Editor’s note: When an out of favour stock (like Blackmores once was) turns higher, alert traders can make an absolute fortune. That’s why Jason’s Quant Trader system scans practically every ASX listing for opportunities. Don’t miss the next Blackmores. Gain access to Quant Trader with a 100% money back trial subscription. Click here to learn more.
PS: All images sourced are owned by Quant Trader unless otherwise stated.