This Share Trading Strategy Could Increase Your Returns Seven Fold

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Life typically rewards us for persisting. It could be in the classroom or the boardroom…the sporting field or the concert hall. Staying the course often leads to success.

Trading is no different. It takes time to develop a strategy. You then have to stick with it when the markets don’t go your way.

But here’s the thing…

A successful trader is also a master at quitting. They will walk away from a losing position without a second thought. Forget persisting. If it’s not working, get out.

This is the great paradox of trading. I believe it’s a primary reason why so many traders fail.

You see, many people struggle to cutting losing trades. Instead, they doggedly hold. This refusal to give up is a disaster in the making.

I’m going to explore this further in a minute. I’ll show you the results of some back-testing I’ve been doing. You’ll see why quitting is vital to success in the markets.

But first, let me tell you short story. It made me think of this very topic.

It’s not an exact science

A few weeks back was the Blackmores Sydney Running Festival. It attracts tens of thousands of people from kids to grandparents.

There are several events on offer. These range from a 3.5km dash over the Harbour Bridge, to the full 42.2kms of the marathon.

It’s a great event and I’m a regular.

This year, I took on the role of an official pacer in the half-marathon.

A pacer’s job is to help a group of runners achieve a particular race time. This means setting the best possible pace and offering loads of encouragement.

My pacing group was the 90-minute runners. These are people aiming to complete the 21.1km course in under an hour and a half. And it takes lots of planning to get them there.

Pacing — like trading — is not an exact science. The rolling course requires constant pace adjustment. My aim is to maintain a smooth effort. This helps keep the group intact.

But it’s never perfect. There is always a dropout rate. Some falter on the hills. Others fade in the final kilometres. I want to slow down for them. But I can’t. I have to maintain pace.

The finish is often as thrilling as it is spectacular. And this year was no exception. It involves a final dash along the harbour foreshore to the Opera House.

Most of my group finished within 30 seconds of the 90-minute goal. I crossed the line with last of the group. Her time was 89 minutes and 58 seconds — barely a moment to spare.

One of my runners came up to me after the race. He asked how I could pace within a few seconds of the target. I said practice and preparation help, but I never know I’m right until after the race.

As I said before, pacing is not an exact science. The pace I set won’t work for every runner. But if I set a consistent level of effort, it will work for many.

Exit stops share a similar logic. They don’t work with robotic precision. You never know if the level was right until after the trade. But exit stops can greatly improve results.

Have a look at the following chart. It shows one of Quant Trader’s recent trades…

Sydney Airport [ASX:SYD] hit its exit stop at $4.86 on 29 June. The sell-offs low $4.85. SYD would still be in the portfolio if the stop had been just two cents lower. But we only know that in hindsight.

This will happen — I’ve experienced it many times in my career. So too has just about every trader that uses exit stops. There is no way to fine-tune a stop to perfection.

Yes, it’s frustrating to see a stock rebound once you get out. But it isn’t a disaster. You can always get back in.

The first objective of a stop is to protect capital. Staying with the trend is a close second.

Now check out this chart for Treasury Group [ASX:TRG] — it’s another of Quant Trader’s trades.

Sometimes a stock doesn’t bounce back. Herein lays the danger. People will say ‘I’ll just give it a little bit longer’. But this reluctance to quit can bring a trader unstuck.

Sure, we could have cut SYD some slack. But we need to be consistent. This means doing the same for TRG. It’s better to miss the rebound than ride a stock to the bottom.

Quitters beat stayers

One of great things about system trading is that we can test our ideas. So let’s do that now. I’m going to show you two strategies — one that uses stops, and one that doesn’t.

Let’s first look at the strategy without stops…

I’ve run this test over the last 10 years. It uses the same entry method as Quant Trader. The only difference is there is no company cap, and it only trades signal 1s.

This is essentially a buy and hold strategy. The system runs its winners…and it’s losers.

There is a wide range of results. The best trade is a gain of 2,369%. But 61 trades fell by 99% to 100%. It’s not a wise strategy to put losing trades in the bottom draw.

The average trade gain over the period is 10.8%. This annualises to 1.9% when adjusted for the holding periods. By comparison, the All Ordinaries returned close to 1% per annum.

This system barely beats the market. A robust buying method only gets you so far. You also need a plan for when stocks go into reverse.

Let’s see what happens when we use an exit strategy…

The chart is almost unrecognisable. This test uses the same entry method as before. The only difference is that I’ve added Quant Trader’s exit strategy.

A plan to quit losing trades changes everything. It helps boost the overall average annualised gain per trade from 1.9% to 13.3% — a seven fold increase.

No exit strategy is perfect. There’ll be times you’ll be stopped out at the low. And that’s okay. These trades don’t lead to career ending losses.

The exit stop is there for the stocks that don’t bounce back. These trades can take you out of the game. It’s better to exit a good trade early than hold a bad trade too long.

Think of a trailing stop as a pacer for your stocks. If a stock can’t keep up, then it is time to quit the position. Hoping a losing stock gets a second wind is a recipe for disaster.

Until next week,

Jason

Editor note: Are any of your stock’s closing in on a record high? Chances are the answer is no. And that’s understandable…it’s been a tough time for the All Ordinaries. But some stocks are surging. They could make a big difference to your portfolio.

Take AMA Group [ASX:AMA] for instance. This small automotive business is on the move. Last week it shot to an eight year high of $1.02. And that’s good for Quant Trader’s members. You see, Quant Trader signalled this stock three times — at $0.37, $0.44, and $0.57. The first entry is close to 175%.

Anyone get gains like these. It’s all about having the right strategies. You can learn more about these here. Look for Jason’s article. The title is ‘It’s an Eagle’s World’.

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The Daily Reckoning
The Daily Reckoning offers an independent and critical perspective on the Australian and global investment markets. Slightly offbeat and far from institutional, The Daily Reckoning delivers you straight-forward, humorous, and useful investment insights from a world wide network of analysts, contrarians, and successful investors. Founded in 1999, The Daily Reckoning is published in 7 countries with a worldwide readership of almost 1 million people.
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