Guidelines for Selling
“Cut your losses short and let your profits run,” is one of the oldest and most lucrative trading maxims. Knowing when to sell is just as important as knowing when to buy. Once you have a good buy (orchestrated by the above guidelines for buying) selling becomes easy, even if you must sell at a loss.
1) “Cut your Losses:” Obviously, there are two types of sales that take place in the market: a sale at breakeven or loss, and a sale at a profit. The first of these two sales is by far the most important. In the stock market, like many other fields, the best offense is a good defense. In the famous quote, “Cut your losses short” comes before any word on profits. Survival is more important than success. Setting a good stop is more important that getting a good buy.
The table shows that it becomes exponentially harder to recover from a decline in portfolio value:
| Percent Loss: |
Percent Gain Needed for Breakeven: |
| 15% |
18% |
| 20% |
25% |
| 25% |
33% |
| 30% |
43% |
| 35% |
54% |
| 40% |
67% |
| 45% |
82% |
| 50% |
100 |
If you followed the buying guidelines and buying/ selling rules outlined above, you have already placed a stop loss on your position. Buying and placing a stop loss go hand in hand: If you did not get a good buy, you will not set a good stop loss. If you don’t know where to put your stop loss, you don’t have a good buy.
Before you place a trade and before a trade becomes profitable your mindset should be one of survival. If you followed the buying guidelines and rules you waited until the market presented you with a gift. You bought at a level with strong technical support. You should place your stop at the closest possible price level at which your technical reasons for getting into the trade have been broken.
Using a tight stop loss fosters better entries, if you get stopped out often you are not being patient enough or your technical reasoning is flawed.
You should be happy when you are stopped out for two reasons:
A. In the market, your own emotion is your greatest enemy. The stop is your greatest friend; your greatest ally against your greatest enemy.
If you do not define your greatest potential loss then you have not plan. If you do not have a plan you will get emotional when you become wrong. When you get emotional, things will almost always get worse.
The stop is there to define your loss. It sets the all important absolute limit on how much money you have to worry about loosing. It allows you to trade with much less emotion.
If you placed your stop loss at a logical level (the closest possible price level at which your technical reasons for getting into the trade have been broken) then the market, by hitting that level, is simply telling you that you were wrong. If the market is telling you that you are wrong, you are wrong. It does not matter what you thought before. The level that you bought at was wrong. You need to get out. You have lost emotional objectivity.
The only price that you will ever pay for having a stop loss is that sometimes you will be stopped out and the market will immediately turn and rally in what would have been your favor, but this will be rare. It is at those times that you must remind yourself that you are in the habit of placing good stops at logical levels because most of the time the market continues lower after your position is stopped out. Think about this statement. See if it applies to your stops. If you are not finding this statement to be true you are not picking good levels, not being patient, and need to stop trading for awhile.
Stops are by far the most important tool in your arsenal. They are the most important tool to master in trading.
Making good buys is good but setting good stops is much more important. Remember, survival comes before success. Defense is more important than offense.
B. If you followed the buying rules and guidelines are seeking to trade with the trend of the market, the direction that you are seeking to trade in is probably still right; you just got into the position prematurely. You are seeking to trade the countertrend and the countertrend move is still occurring. What’s the good news? The countertrend move that you were seeking to fade is increasing. The potential upside for your countertrend fade is increasing. To return to the gift analogy the market is saying, “I have an even better gift for you.” However you cannot accept that better gift if your portfolio is already considerably invested in accepting the old one. True, you could average down, but that would only constitute accepting a percentage of the new gift price. In addition to this, if you did not get stopped out and are choosing to average down you are exposing yourself to the trade more than you originally intended. Most importantly, you become emotional and loose objectivity.
The most important concept to keep in mind about setting stops is that they work to your advantage most of the time. Bad stop-outs will happen; as stated earlier there will be times when you feel tremendously frustrated about stops. You will at times be stopped out of a great position just before it finally turns. Learn to accept that “bad stops” happen.
Be in the habit of setting your stops “at levels at which your technical reasons for getting into the trade (at a certain price level) have been broken.” If you consistently do this, and your buy levels are valid, you will be glad when you are stopped out more often than not. Most stop-outs will be “good stops.”
Remember that “good stops” either: A) simply stop you out of a bad trade. Or B) allow you to re-assume objectivity and buy a new, better price at a new level. In either case they are very good for your portfolio.
If you find that the majority of your stops are not “good stops” you should stop trading and re-analyze your market outlook.
2) “Let your Profits Run:” Now your trade is making money. When do you sell? -Don’t sell. Trail your gains and let the market stop you out. Don’t limit the amount of money that the market can give you. Let your profits run.
There are two broad types of selling: 1) Trailing a profitable position up with a stop loss to lock in profits and letting the market stop you out profitably (either manually or with a TS trailing stop). And 2) selling at a clear resistance level that you strongly believe your up-trending asset will fail to penetrate.
The first of these two profitable sales is the best at least 75% of the time. Trailing a profitable position as it goes up is the concrete manifestation of the “let your profits run” concept. There is only one downside: you will always leave a little money on the table and you will never sell at the absolute top. Why is this still the best thing to do most of the time? Because you don’t know what the market is going to do. If you have faded a countertrend then the trend is in your favor, the market will often go on to make new relative highs after a countertrend move. If you sell at a hard target, you are telling the market: “Thanks, but that is all of the money that I want.” If you trail your position as it goes up you put no limit on how much money the market can give you.
A fine line must be walked between optimism and pessimism when trailing a profitable position up. Don’t be too optimistic; when you see your asset approaching a strong technical price ceiling you should tighten up your stop loss significantly. If the asset breaks through the price level and continues up you are still in the trade. If the asset bounces down you have already taken steps to lock in as much profit as possible. (Note: If asset appears to have successfully pierced the impeding resistance level, you may want to loosen your stop once again because the odds that the ceiling will hold have been reduced by the ceiling piercing and further upside may be imminent.)
Also, as the rules section states, when a position moves profitably and establishes a new base above your entry level you must move your stop very close to the lows of that new base. Constantly locking in profits by moving your stop up to the lows of newly formed bases is key to success.
