The Secret to Great Trading Isn’t Buying, It's This Strategic Decision

It is often said that successful trading is simply a matter of cutting losses and letting profits run. That logic is irrefutable, but like most pithy advice, the challenge is the actual implementation of the general concept. It is easy to state the rule but quite difficult to actually live it.

Most people are fairly good at buying and holding a stock, but they are very weak at selling losers and taking profits. One of the problems with stock market advice is that the vast majority of it is focused on the buy decision. I would guess that at least 90% of the stories about stocks are about which ones you should buy. It is very rare to see advice about strategic selling.

Most people believe that the main thing that determines investing and trading success is buying the right stock. While it is true that finding a great stock will offset many mistakes, it is the sell decision that influences your ultimate success to a much greater degree.

It is very rare to see advice about strategic selling.

Anyone can buy and hold a promising stock, but it is the ability to cut losses and take gains that make the biggest difference in the level of returns. Everyone knows someone who bought a great stock and made a lot of money, but then they gave it all back because they had no idea how to sell it effectively.

The biggest benefit of making sales is that it helps you control your emotions and allows you to be more patient while waiting for a stock to perform. I constantly adjust the size of my position in a stock so that I’m ready to rebuy even more aggressively when I feel that conditions are right. When you hold a very large position in a stock that you like, then pullbacks and dips can be very frustrating, but if you are always in a position to be able to buy, then those dips are welcome and become great opportunities.

Using Selling as a Strategic Toll

The key to using selling as a strategic tool is to always be mentally prepared to rebuy a stock that you sold. There is often a reluctance to do this as it is a tacit admission that you made a mistake by selling in the first place.

The reality is that selling is nothing more than a form of insurance. It is a tool and not an admission that you made an error. Selling reduces your risk. It is better than any hedge, and if you have to rebuy at a higher price, then it is tantamount to paying an insurance premium.

I like to think of selling as a tool for managing emotions. I don’t want to fear minor pullbacks in stocks I favor. I want to capitalize on the inevitable volatility.

Selling boils down to two basic approaches: trailing stops and selling into strength. Each has its advantages and disadvantages, and what works best will depend on the overall market action, the nature of the stock, and your style of trading.

Trailing Stops

The trailing stop is probably the most common method used by traders. For a position trade, you might set a price level of maybe 7-10% below the current price and keep on moving it up as the stock runs. This works great in a strong market with trending stocks.

As long as there isn’t any great volatility along the way, you keep building your profits, and then you exit, lock them in, and then look for a chance to rebuy. You may rebuy lower or maybe higher. It doesn’t matter. What matters is better technical conditions or some sort of news catalyst.

Selling Into Strength

The other main approach to selling is to sell into strength. This works best when conditions are choppy, and stocks are volatile. If stocks are moving around quite a bit, a trailing stop doesn’t provide much profit potential. If you set them too tight, you will be quickly stopped out, and if you set them too loose, then you increase your risk of big losses.

A selling-into-strength approach allows you to lock in your profits and then maybe give it another try as the stock moves around. The big risk is that the stock will start to trend, and you will be left behind, but more often than not, stocks will give you numerous opportunities to reenter.

You can never know for sure which approach to selling will work the best. It changes all the time as the market action changes, and it will vary with each stock that you trade. I find that it works well to use a mixed approach. I’ll take some partial profits into strength, but I’ll hold a portion of my shares at a trailing stop. If the stock continues to run, I may wish that I held on to more, but quite often, I’ll rebuy at higher profits if the momentum looks strong.

Bottom Line

I’ve just scratched the surface of the sell decision in this article, but the most important point I can make is that you must have a strategy. The biggest mistake people make is that they buy a stock and then have no plan on what they will do as it moves up and down.

At a bare minimum,, set a loose trailing stop and keep in mind that just because you are stopped out, it doesn’t mean that you can’t buy the stock again. The important thing is to limit your losses systematically.

More Trading Basics

At the time of publication, Rev Shark had no positions in any securities mentioned.