One of the biggest challenges facing traders (read: investors) is when to sell. In fact, I’d say failure to understand this area is responsible for more lost profit and capital than any other reason.
Usually I find a trader will be armed with many theories on how to pick the best trades to enter the market, but when asked where they should exit you often get a confusing array of examples and in most cases, more guesswork than solid theory. This is also how the majority buy shares and other investments, but that is another story. Herein lies the problem of the modern trader.
The simple fact is that if you want to be a consistently profitable trader, not only do you need to know how and why you are entering a trade, but more importantly, you need to know when and where you will exit. A common statement made by many traders is that they only ever achieve a good profit if they can pick their entry well. However, while this statement has some merit, it is only partly true, and it’s not the most important element of being a successful trader.
Anyone can pick a share that will rise, just the same as anyone can pick a share that will fall. As long as the winning trades outperform the losing trades, you win overall. To achieve this, it’s not just about picking winning trades: rather, trading for profit is about using sound money management rules and good exit strategies. When teaching traders, my common mantra is “it is not how much you make; it is how much you do not lose that determines your wealth”, and this mantra is true for any investment, including business.
You have probably heard the statement ‘You can’t go broke taking a profit’. But in my opinion, this is a myth. It’s detrimental to your trading, and will set you on a path to financial mediocrity as it will cost you a lot of money.
You can be right in four out of every five trades but your success and profitability will depend on how you handle each trade in regard to your money management and exit rules. If you have four winning trades that make 10% each and one losing trade that loses 10%, then you are profitable. You can also have four winning trades that make 10% and one losing trade that loses 50% and you are unprofitable.
If we allow losing trades to continue to fall beyond what is an acceptable level, we put our whole portfolio in an unprofitable position. This is exactly what happened to many Australians’ personal portfolios, superannuation and other managed portfolios during the GFC and it’s why so many are still struggling to get their portfolio back to the level it was pre-GFC.
Think about how many times have you decided to take profits on a trade before the stock told you that it was unlikely to rise any further? And how many times have you lost 40%, 50% or more in a trade? Perhaps you are one of those people who mistakenly believe that if you do not sell, then you do not have a loss. Let me help you to be realistic here: you do have a loss, it is just that you have not realised the loss that is killing your portfolio returns.
Just as all businesspeople need to have an exit strategy, so do you with all of your investments. It seems as businesspeople we are doing SWOT analysis, research and business plans to enable us to make wise decisions for the profitability of our businesses.
We also have lines set that identify when we need to cut unproductive staff, products and business units, but what happened to doing the same for our personal investments? That’s another story!
So how do you know when to hold onto shares and other investments, and when to sell?
The simple answer is really dependant on the length of time you want to trade and the type of market you are trading.
Remember that no market is 100% black and white and therefore, as a trader, you need to allow room for the market to move through its cycles.
However, one cannot say that a market or stock will turn at an exact point in time or price as we can only indicate with high probability derived from our analysis what is likely to occur.
One of the most important rules I know is to trade on confirmation and not on speculation, which means that you should never make a decision until the market/stock tells you what it will do.
In part two of ‘Selling for profit or just selling out’ I’ll discuss specific strategies for exiting shares.