Why You Should Set Up A Trailing Stop on your Share Trades

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What does it take to make a super profit in a single stock?

Many people will tell you it’s all about the research. They’ll say big returns require expert analysis to buy at the right time.

Others say you need a whiz bang technical indicator…a secret formula that can identify turning points and get you in at the bottom.

But do you know what? They’re wrong.

You see, both of these methods centre on when to buy — this is where many traders focus their attention. They believe the entry point is the most important part of the trade.

Sure, entries matter. But they’re not the most critical factor.

The key to making super profits revolves around your strategy to sell. This has the greatest impact on your results. It’s the swing factor that separates the best traders from the pack.

I talk a lot about letting winners run and cutting losses. It’s a simple concept. But it can be hard to do. In fact, many traders find it easier to do the opposite — cut profits and run losses.

And the research supports this.

One study examined 78,000 accounts at a US discount broker. It found that, between 1991 and 1996, traders were 1.8 times more likely to sell a stock that was up 20%, versus one down by 20%.

Another study, using data from 10,000 accounts between 1987 and 1993, backs this up. It found traders lock in profits at a 50% greater rate than losses.

Then there’s a study on 4,330 accounts at an Israeli brokerage. It found the holding period for losing trades was roughly double that of winning trades.

Local researchers had similar findings. They looked at trading volume after a company listing. It turns out volume was lighter when shares opened below the offering price — in other words, people were hesitant to sell at a loss.

I could go on. But I’m sure you get the point. People find it easier selling their best stocks, while holding their worst performing ones. And it’s a key reason why they don’t make the profits they otherwise could.

Quite simply, selling winners, and holding losers, is a fatal mistake.

I wrote about cutting losses two weeks ago. You can review that update here — just look for my article. This week, I’m going to talk about letting winning trades run.

Riding a mega trend

Okay, let’s get started. I’m going to use Quant Trader’s best live signal as an example. It was also the ASX 200’s top performing stock in 2015. The company’s name is Blackmores [ASX:BKL].

Have a look at this…

Source: Quant Trader

Blackmores is a pin-up stock for trend following. It shows why Quant Trader doesn’t take profits. The strategy is about letting profitable trades run as long as possible.

The first signal was at $33.93 on 23 December 2014. There were two subsequent signals at $39, and $44. BKL is currently $179.28 — the respective gains are 428%, 359%, and 307%.

Yes, the entry points were good. But that alone isn’t enough. The key to catching super trends comes down to one thing — resisting the urge to take an early profit.

Ask yourself this. Have you ever had a 20% gain and took it? I know I have. A quick-fire profit can be hard to turn down.

But here’s the thing. Traders who take small gains never get a Blackmores. It’s impossible. They cut every stock with the potential to run before it’s barely off the ground.

There’s only one way to get 100% plus gains — you have to let your winners run.

The number one reason people cite for cutting winners early? Fear. People worry about giving back their profits. And I understand this — it’s no fun watching a profit whittle away.

But you know what? There’s no other way to stay in a trade. You have to accept giving back some of your gains. This is the price of riding a trend like Blackmores.

Quant Trader uses a trailing stop to exit a trade. You can see it on Blackmores trade chart. It’s the dotted red line below the share price.

A protective flaw

Blackmores’ exit stop is currently at $153.81 — that’s about 11% below the current share price.

People sometimes ask why Quant Trader risks giving back so much. They say it would be better to increase the exit point to protect the large profit. This sounds reasonable, but there’s a flaw.

You see, just about every trend zigs and zags its way to the top. That means you need to give a stock room to move. Bringing your stop in too close increases the odds of an early exit.

Take Blackmores for instance. It’s a top performer…but it hasn’t traded higher with each and every day. There have been pullbacks along the way. And these have a habit of shaking out many traders.

Here are a few of Blackmores’ corrections: 18%, 15%, 19%, and 22%. Many people find these hard to sit through. They worry they’ll give back their gains, so they sell.

Think of it like a rodeo. The bull is always trying to buck the cowboy off. It’s about making the ride as unpleasant as possible. The winner is the cowboy who stays on the longest.

Stocks are no different. Successful traders have a knack for holding. They don’t flinch at moderate corrections. Their aim is to stay with the trend as long as they can.

Blackmores is still an open trade. It’s impossible to say how much further, if at all, the shares will run. And that’s okay. We have a strategy for that — keep holding until the price hits the trailing stop.

Good research and robust technical indicators will only get you so far. It’s your decision on when to sell that determines how much you make or lose.

A trailing stop is the best way I know to manage exits. It can give you both the discipline and confidence to stay the course. That’s how you catch the mega trends.

Until next week,

Jason

Editor’s note: When an out of favour stock (like Blackmores once was) trends 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.

Jason McIntosh

Jason McIntosh

Jason is a professional quantitative analyst. Before he graduated in 1991 he joined Bankers Trust — a Wall Street investment bank — to be a trader. After Bankers Trust was taken over in 1999, Jason, already financially independent, co-founded a stock market advisory and funds management business called Fat Prophets. At 37 he sold his part of that business and retired. These days, he’s a private trader and system developer. In 2014 he launched the wildly successful trading service: Quant Trader.
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