Is selling half of a winning trade smart?
Many traders think it is. It’s one of the most popular strategies I see.
And it’s not just retail traders. Plenty of professionals agree. There’s something about partly cashing out a profitable trade that appeals to people.
I know a bit about this strategy. You see, I’ve used it a lot over the years. I’ve also seen many colleagues scaling out of positions. So if popularity is any guide, it must be a winner.
There are lots of variations to this strategy. Mostly they involve when to sell. Some traders use a technical indicator as a guide. Others use a dollar value or a fixed percentage.
I tested a number of these methods early in my career. They all offered a different twist on the strategy. But there was one I liked best — maybe you’ve tried it yourself.
Here’s how it went. I’d sell half when the profits covered my remaining risk. This meant my worst overall result was breakeven. I reasoned it was like getting a free trade.
If only it was that easy.
Yes, it felt good to bank a profit. It was also nice to know I wouldn’t end up with a loss. But there was a glaring hole in this strategy.
You see, I was halving the size of my winning trades relatively early. Meanwhile, my losing trades were full strength. This meant my winners had to work extra hard. It was far from optimal.
The simple reality was I needed to get more profit from my winners. This variation of selling half was holding me back — it was a profit minimising strategy.
Think of it like this. A footy coach doesn’t rest his best players after a few minutes. He’ll give them time to make an impact. The same logic applies to trading. Why sell off a promising trade just as it gets going?
But say you have a big profit. Is this a better time to sell half?
Well, that’s what we’re about to look at.
A quick recap
Recently I’ve written a lot about the question of when to sell. The inspiration for was an email from a Quant Trader member. Here’s an excerpt of what he said:
‘Now, I need to learn about the overall benefits of selling half of a winning stock, while letting the remainder run. Several PPP editors have proposed this strategy.
‘Here’s an example of one of my own trades — a 10-bagger in LNG Ltd. I bought my first $500 worth of shares at $0.19 in May 2013. I later bought four more lots at different times between $0.28 and $0.335. My total investment was $2,508, or 10,000 shares.
‘The stock hit a high of $4.45 — a 2,347% gain from my first shares bought at $0.19! I sold 5,000 shares at $3.35 in August 2014, and then 2,500 shares at $2.06 in December 2014. This resulted in a $22,000 payout. I eventually sold my remaining shares for $2.65 in August 2015. The total profit from the trade was $27,855. Nice — thank you, LNG.
‘I don’t expect you to give personal advice. But I’m sure other readers would appreciate your comments on the strategy of selling half of a winning trade.
This is familiar territory. It’s a question I first asked more than 25 years ago…and there’s every chance it’s crossed your mind too.
I initially responded in a Quant Trader update with two charts. The first was of Peter’s sell half strategy for LNG. The other was how Quant Trader would have traded the same position.
The overall result was interesting. Peter ended up with an average selling price of $2.85, while Quant Trader’s trailing stop exited at $3.01.
Holding — and not selling half — gave a bigger profit.
But this is just one trade. I don’t think you can draw meaningful conclusions from this. Luck can play a big hand in once-off situations. And that’s something no trader should rely on.
A proper response to Peter’s request needs more work. You see, I want to see a strategy play out many times. That’s the best way I know to decide if it has merit.
So let’s have a close look at selling half a big winner…
Test before you trade
There are two ways to test a strategy. You can use trial and error — like I did when I began my career — or you can use backtesting.
The biggest disadvantage with trial and error is that it takes time. There’s also a risk that you choose a period that has a bias for or against what you’re testing.
A computer and lots of data gets around both issues. You can learn more in one afternoon than in a few years of live trading. Backtesting can give you a big advantage.
So this is what I did. I designed a test to see which strategy makes more money — selling half, or holding on. Let me tell you a bit about it.
The first scenario uses Quant Trader’s standard entry and exit method. The only change is there’s no 100 company cap. This ensures identical portfolios for the two simulations.
It also opens the test to more than 4000 trades. This makes the results a lot more meaningful than looking at just one stock — like Peter’s trade in LNG.
Scenario 2 has one important difference. I’ve coded it to sell half if a stock increases by 100%. The balance will remain open until it triggers the standard trailing stop.
Now, I could have used any number of triggers to sell half. But I chose 100% — this is a popular figure that I often see in use. I’ll talk a bit more about this later.
Okay, what do you think you’re going to see?
Take a moment. I want you to think about what’s going to happen, and why. This is a fun way to test your trading logic.
Right, now let see the results…
Now let me explain what’s going on.
The start date for the simulation is 1 January 2009. This includes four years that the market rose, and three that it fell. I’d describe these as typical trading conditions.
The results assume $1,000 on every long trade. As always, there’s no allowance for costs or dividends. And I’m only using signal 1s.
There’s a high correlation between the profits for both strategies. But the one depicted by the blue line is gradually pulling away — it has an edge on its cousin.
Are you able to identify the blue strategy?
I’m sure you can. It’s the one that keeps the entire position. There is no selling half.
I’ve got another chart for you. It plots the margin between holding the lot and selling half.
Have a look at this…
The result from this test is clear cut. Resisting the urge to sell half is generally more profitable.
As a rule of thumb, profitability increases along with the threshold for selling. For example, selling half at 100%, rather than 50%, generally gives a better overall result.
But this doesn’t mean you should never partially sell a profitable trade. It all depends on what you’re trying to achieve. Selling half may be the right strategy for some people.
An advantage of selling half is that it can reduce volatility.
You see, as a stock rises, it’s weighting in your portfolio typically increases. This makes the portfolio more sensitive to its price changes. Scaling back a profitable trade reduces this sensitivity.
Personally, I prefer to let all my profits run. I think this is the most pure form of trend following. But if you want to take some profits after a big run, that’s perfectly okay.
I’m not a fan of solely using a fixed percentage — like 100% — to sell half. A stock could be powering higher and you sell just because it’s reached a certain level. That just doesn’t stack up to me.
I’d rather combine a target with an indicator. For example, if a stock is up 100%, and its rate of momentum slows, then sell half. This helps avoid an early sale while the trend is strong.
I also like research to back up my actions. You need a good reason to buy a stock — so why should your exits be any less thoughtful?
We all like to bank a profit. It makes us feel like we’re getting ahead. But be careful not to sell too soon. Doing so can greatly limit the profits of your best trades.
Until next week,
Editor’s note: Exit strategy is one of the most important decisions you’ll make. Yet, despite its importance, selling is an afterthought for many traders. This can be a costly mistake.
Quant Trader uses a stock’s recent volatility to determine when to sell. This tailors the exit level to each situation. It’s not just about holding on to winners longer. It’s also about getting you out when the trend turns lower.
So if you’re not sure when to sell…I strongly suggest you look into Quant Trader now.
Try it. See if it makes sense to you. It could change the way you trade forever.