Avoid This Costly Trading Mistake — Do This Instead

Avoid This Costly Trading Mistake — Do This Instead

Deciding when to sell is hard…

Should you hold-out for a better price, or sell at current levels?

Getting this right is crucial. Your decision could greatly affect your success as a trader.

Sadly, many people get this hopelessly wrong. Some struggle with uncertainty and make rash choices. Others apply everyday logic, without realising the laws of trading can be different.

I’ve done a lot of work on selling strategy over the years. First by trial and error, then later using algorithms. And I can tell you this: Your exit strategy can make a huge difference.

I’m going to talk more about selling in a moment.

But, first, have a read of this email from a subscriber to my premium investment service, Quant Trader

I’m a new subscriber to your service. I’ve begun by testing the outcomes we have attained on some stocks we’ve held (and sold too early) in comparison with your signals on those same stocks. We were impressed; had we bought on your signal 1, and not sold when we did, we would have been much better off.

However, I was surprised to see how low you’ve set your stop-losses. To consider the first holding in your portfolio as an example, you recommended an entry to A2M on 28-Nov-2016 at $2.29, with an exit stop at $1.71. A2M is currently trading at $3.30. You have now raised the exit price to $2.56. That seems still very low.

My charting program (F-Charts) sets exit-stops at twice a stock’s ATR, and raises it as the price increases; for A2M, that is now at $3.00. That strikes me as a more reasonable level at which to protect profits.

Could you please explain why you set the stops so low?

Wouldn’t such a large exit stop ensure:

a) Bigger losses on losing trades; and

b) Give back too much profit when the trend turns down.

Do you always rely on hitting the exist-stop before selling? Or do you lock in a partial profit by selling half a holding? (Taking profits has been an important strategy for us).

Any advice would be much appreciated.

Member,
Richard

Richard asks some excellent questions about selling strategy. You may have thought about these yourself. I believe traders struggle in this area more than any other.

I’m going to tackle Richard’s questions over two updates. I’ll start by discussing the size of Quant Trader’s exit stops. Then next week, the focus will shift to the strategy of selling half.

I think you’ll find this series fascinating. It could make a real difference to your trading.

OK, let’s go…

When do you sell?

Many people say good entries are the key to trading success. But I disagree. I believe your exits are more important. This is what determines if you win or lose.

Professional traders often use a ‘stop loss’ to exit a trade. This is a pre-set level below the current share price. They’ll sell their shares if the market pulls back to this point.

Now, there’s no single best strategy for setting stops — it all depends on your goals.

For instance, a swing trader may use tight stops. Their aim is to make a quick profit over a short period (possibly a few days). This means their exit point is usually never far away.

But if you’re targeting medium term trends, then bigger stops are often better. These help you stay with a trend. And the longer a trend lasts, the more money you could make.

Quant Trader’s initial exit stop for long trades is around 25%. This strikes a balance between avoiding exits on small pullbacks, and limiting downside.

Then there’s the trailing stop. This is an exit point that moves higher as a stock rallies. Many traders use a fixed percentage, say 20%. If a stock falls by this amount, they sell.

Quant Trader calculates trailing stops differently. It uses a multiple of a stock’s recent average daily trading range (or ATR). This dynamic process tailors the stop to each trade.

Now, you may recall seeing ‘ATR’ in the earlier email. Richard says his charting program uses ATR to sets trailing stops. This is the same process as Quant Trader.

But there’s a key difference.

You see, Richard’s program sets stops at twice a stock’s ATR. This is a relatively close exit point. A stock only needs to fall by its ATR for two days to hit the stop.

Quant Trader has a much wider trailing stop. The system’s exits are 10 times the ATR. This gives a stock plenty of room to move, and increases your odds of staying with the trend.

Flawed logic

Richard makes an interesting comment. He’s been comparing Quant Trader’s exits to his own. This is what he says…

I’ve begun by testing the outcomes we have attained on some stocks we’ve held (and sold too early) in comparison with your signals on those same stocks. We were impressed; had we bought on your signal 1, and not sold when we did, we would have been much better off.

Quant Trader isn’t just about trade signals. I also want to help my readers become better traders. And one of the best ways to do this is to study past trades (just like Richard has been doing).

Richard’s example is The a2 Milk Company Ltd [ASX:A2M]. You’ll find this stock in both Quant Trader’s regular portfolio, and the Overflow.

Here’s what it looks like…


[Click to enlarge]

This trade is from the Overflow portfolio. It shows Quant Trader’s earliest entry date. A2M didn’t appear in the regular portfolio for another three months (due to the 100-company cap).

Let me step you through the trade…

Quant Trader’s buy signal was at $1.90 on 2 August 2016. The initial exit stop was at $1.43, or 24.7% below the entry level. The red line under the share price tracks the changes in the exit stop.

You’ll notice the exit stop doesn’t initially rise with the share price. This gives the trend extra breathing space. Based on back-testing, I believe this increases the odds of success.

A2M’s exit stop starts to rise on 24 August. You can see the red line step higher on the chart — it increases to $1.68. The exit level then remains steady for five months.

People often question these big, slow moving, stops. They believe closer stops would protect more profit when the shares turn lower (or reduce a loss if the trade fails).

This sounds logical, but there’s a flaw.

You see, bringing the stop in too close creates a problem. It typically results in a stock hitting its exit point sooner. This can get you out of a profitable trade unnecessarily.

Let me show you what I mean…


[Click to enlarge]

Here’s another chart for A2M. But this time, I’ve set the stop much closer.

Let me explain what’s happening…

In this example, an exit occurs if the shares fall by three ATR (remember, ATR is the average daily trading range). Richard talks about a two ATR stop, while Quant Trader’s ATR exit is 10.

Now, you’ll see there are three trades on the chart. This is a side-effect of closer stops — it typically leads to more activity, as trades hit their exits more often.

You’ll also notice the stops hug the share price. The smallest correction will often end a trade. This is more akin to short-term trading styles.

So, yes, a close stop is quicker to protect profits. But those profits may be relatively small.

The respective results for the three trades above are: +5.8%, -1.3%, and +25.2%. Compare this to Quant Trader’s single trade, which is currently ahead by 71%.

Here’s the thing: A close exit stop may feel more secure. But it makes staying on a typical medium-term trend next to impossible. These big trends need room to move.

Next week, I’ll tell you about the other popular ‘safe play’ — taking profits. You’ll get an insight to why so many people struggle to make money trading shares.

Until next week,

Jason McIntosh
Editor, Quant Trader

Editor’s note: Does your exit strategy keep you on the big trends? I mean, the trends that go on for months, and take a share price more than 100% higher.

Don’t worry if the answer is no. You’re not the only one. Many people miss out on the full potential of the big trends. But here’s something you should do…

Check out Jason McIntosh’s Quant Trader advisory service. It uses algorithms to pinpoint when to sell. The aim is to ride uptrends to maximise profits. This is how the system captures gains like 353% in Blackmores [ASX:BKL], 199% in Vita Group [ASX:VTG], and 147% in HUB24 [ASX:HUB].

So, if you’re not sure when to sell…I strongly suggest you check out Quant Trader  .

Try it. See if it makes sense to you. It could change the way you trade forever.

PS: All images are sourced by Quant Trader, unless otherwise stated.

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