When should you lock in a profit?
Think about this carefully. Your answer could influence your odds of success.
People often tell me that a trader shouldn’t be greedy. These people like the certainty of banking a modest profit. They say it’s better to sell early than risk a lower price tomorrow.
But what if prices keep rising?
I’ve seen many traders come and go over the years. One of the biggest reasons they fail is due to a poor exit strategy. Their mistake often comes down to cutting profitable trades too early.
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This week I’m going to give you an insight to how I trade. You’ll see a stock from my own portfolio. It will help you understand why I believe running your winners is so important.
But first, have a read of this:
‘Having traded with Quant since earlier this year I am still a bit vague about profit taking. From reading all your articles, it seems to me you only sell when your stock hits its exit stop (having let a winner run).
‘Please confirm that I am correct because I sometimes look at a trade that is up a reasonable amount and ask myself if I should be taking the profit.
‘A good example is the recent exit from Reliance Worldwide Corp. Ltd [ASX:RWC]. I entered at $4.61 and the stock rose to a high of $6.38 in August. The shares then slid back, and I missed the opportunity.
‘I know your answer will be stick to the system. But I just want to understand that I am doing this the right way.’
Neil describes a classic situation. Should you cash in an early gain or let it run?
Here’s the stock in question:
You can see Neil’s entry and exit points on the chart. Despite getting off to a good start, the trade gave back most of its gains when the shares fell back.
Now here’s the question: Was this a lost opportunity?
Well, I don’t think so.
Although there was the possibility of a 38% gain, this would require Neil selling at the stock’s high of $6.38 — a feat no one consistently achieves.
Quant Trader doesn’t try to predict a stock’s high. Rather, the strategy aims to stay with trend until the trailing stop is hit. That’s how the system maximises its profits.
Sure, RWC didn’t result in a big win — the reality is many trades won’t reach their potential.
And that’s OK.
It’s the rewards from the stocks that do run that matter most. These trades could potentially double, triple, or more. And it may only take one of them to really boost your returns.
In the hot seat
OK, let me show you what I do.
Have a look at this chart:
This is the share price chart for Appen Ltd [ASX:APX]. There’s a good chance you already know a little about this stock. It’s been in the overflow portfolio since July 2017.
APX went on my buy list last year. The shares were at an all-time high, and up almost 100% in the previous six months. I bought a stake at $4.57 on 5 September, 2017.
Now, I know many people are nervous buying after a strong move. They reason that a stock must be nearing the end of its run. Their overriding concern is to avoid buying at the top.
But this is often a mistake.
You see, a strong share price is positive. I believe it’s the best indicator that a rising trend will continue. And some trends continue for a very long time.
Here’s the next chart:
Buying near the all-time high was a good call. APX quickly ran to even higher levels. My shares were up 41% in only six weeks — it was a terrific start to the trade.
Now, this is where many traders struggle. They know they should hold. But the lure of a quick profit is often irresistible. They also fear that a correction will wipe out their gains.
Think how you’d handle this trade. Would you cash in your chips, or let it ride?
I’ll tell you what I did: I held on.
Now, letting a trade run involves risk. It means accepting that an early gain could vanish — as was the case with RWC. The 100%-plus winners are the reward for that risk.
This is what happened next:
APX fell 25% in just three days.
It was similar to Nigel’s experience with RWC — most of my paper profit went up in smoke.
So was not taking an early gain a mistake?
Not at all. Letting the trade run was the right decision for my strategy. That’s how I’m able to get share price moves of over 100%.
When the correction hit, my stop-loss for APX was at $4.64 (just above my $4.57 entry point). I was ready to give it all back for the chance of a much bigger gain.
You see, most of my trading profits come from stocks that run a long way. Banking an early profit caps this potential. That’s why I let my winning trades run.
Stay along for the ride
So, what happened to APX?
It turns out the sharp fall was just a correction.
Here’s the final chart in the series:
The early selloff appears as a blip in a bigger upward move. There’s been other corrections along the way. But I’ve been able to ride them out and stay with the trend.
Holding a stock is always easier in hindsight. The corrections often seem to fade into the background. Many people forget about them entirely.
But real time is different. You simply don’t know if you’re holding an RWC or an APX.
I find it helps not to watch each stock too closely. Riding every movement can be emotionally draining. It often pays to take a step back from the coalface.
You see, not having APX at top-of-mind made it easier. I was able to sit through the corrections without worrying. My trailing stop was in place. I just let the market do its thing.
APX hit a record high of $16 in August. The shares have since been pulling back with the broader market, and triggered my exit stop.
No, I didn’t exit this trade at the high — and that’s OK.
My aim is to get the big middle part of a trend. This is where I make most of my profits.
APX resulted in a 115.5% profit. I couldn’t have gotten this far if I’d sold for a 20–30% gain. My willingness to give back a modest early profit has made this possible.
No one knows how high a stock will rise. Some trends do little, while others do a lot.
But I do know this: Letting your profits run is the key to banking triple-digit winners.
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Until next week,
Editor, Quant Trader