Sit back and imagine this…
You’re looking across a sprawling room full of traders. Some are standing with a phone to either ear, while others yell stock prices to colleagues. It’s a chaotic scene full of noise and activity.
Then, above the commotion, you hear: ‘Whoo! I just bagged the elephant!’
Clenching his fist, a young trader jumps to his feet. He then turns and high-fives a colleague. It’s the unmistakable sign of success. He’s just had the biggest win of his career.
You may recognise the scene…
It’s from the 1987 movie Wall Street. The film may be fictional, but it captures the look and feel of the dealing room perfectly. It’s a setting I remember well.
The previous quote is from up-and-coming broker Bud Fox (played by Charlie Sheen). You see, Bud had just landed his biggest ever client — the infamous Gordon Gekko.
So how did Bud ‘bag the elephant’?
Well, it came down to two things: persistence, and a good idea. These are the key ingredients to just about every success story — no matter what the challenge.
In a moment, I’ll show you how to bag the elephant. No, I won’t be talking about winning a Gekko-style client. Instead, I’ll be telling you how to potentially land a triple-digit stock gain.
But first, this is where many traders go wrong…
Many people believe it takes expert financial analysis to make big profits. Others say you need a whiz-bang technical indicator to identify when a stock is about to rise.
But do you know what?
You see, both of these methods centre on one thing: when to buy. And this is where many traders focus their attention. They believe the entry point is the most important part of the trade.
Sure, entries matter. But they’re not the most critical factor.
What really matters, in my view, is your selling strategy. This has the greatest impact on your trading results. It’s the swing factor that separates the best traders from the pack.
I talk a lot about letting winners run and cutting losers. The idea is to resist the urge to sell your profitable trades, while being relatively quick to exit when a stock falls.
But many people do the opposite: they sell their winners early, and let their losers run.
And the research supports this…
One study examined 78,000 accounts at a US broker. It found that between 1991 and 1996, traders were 1.8-times more likely to sell a stock that was up 20%, versus one that was down 20%.
Another study using data from 10,000 accounts between 1987 and 1993 backs this up. It found traders lock in profits at a 50% greater rate than losses.
Then there’s a study on 4,330 accounts at an Israeli brokerage. It found the holding period for losing trades was roughly double that of winning trades.
Think about that for a moment. People were running their losses, and cutting their profits. This is the exact opposite to how many of the most profitable traders operate.
Local research follows the same pattern…
One study analysed trading volume on new company listings. It turns out volume was lighter when a stock opened below the offering price — people were hesitant to sell at a loss.
I could go on, but I’m sure you get the point.
The fact is that many people are quick to sell their winners, and slow to cut their losses. This is a key reason why they don’t get the triple-digit winners.
A few weeks back I did a survey of Quant Trader members. One of the sections was about the challenges they face as traders. It turns out the biggest issue by far is: when to sell.
And I can understand why…
Selling is a highly uncertain time for many people. They wonder if they should hold out for a better price or risk lower levels. The result is often smaller profits and bigger losses.
I’ll talk about exiting losing trades another time. That’s a big topic on its own.
But today, I’m going to focus on selling a profitable trade. I believe that getting this right is one of the quickest ways to improve your trading results.
OK, so the stock you’re about to see is one of Quant Trader’s live signals. It’s an example of how the system trades a big trend. I trade this way myself — and I want you to be able to do the same.
Check this out:
This is the share price chart for Pinnacle Investment Management Group Ltd [ASX:PNI]. The company operates a financial services business, and is currently in the ASX 300.
PNI is a pin-up stock for trend following. It shows why Quant Trader doesn’t take profits. The strategy is about letting profitable trades run for as long as possible.
The initial buy signal was at $2 on 26 September 2016. There were also entry signals at $2.32 and $2.54. The eventual sell signal was at $5.76 — locking in gains of 188%, 148% and 127%.
Sure, the entry points were good. It certainly helps to buy early in a trend.
But that alone wasn’t enough.
The key to making three triple-digit gains was to resist an early profit.
Ask yourself this: Have you ever sold for a quick 20% gain?
I know I have. A quick-fire profit can be hard to turn down.
But do you know what?
Traders who take small gains never get a Pinnacle. It simply isn’t possible. That’s because they sell their winners before the shares really get going. This caps a trade’s potential.
A reason I often hear for quickly selling a winning trade is fear. People worry about giving back their profits. And I understand this — it’s no fun watching a gain whittle away.
But here’s the thing: You have to risk losing a small profit to potentially get a larger one. There’s no way around this. The rewards for accepting this risk are the trades like PNI.
Quant Trader uses a trailing stop to exit a trade. You can see it on Pinnacle’s chart. It’s the dotted red line below the share price — it looks a bit like a set of stairs.
A trailing stop won’t get you out at the high. But it does the next best thing: It helps keep you in a trade for longer. This is how you potentially ‘bag the elephant’.
I’ll tell you more about trailing stops next week. You’ll see why they’re a crucial part of my trading strategy. Hopefully they’ll be an equally important part of your strategy, too.
Until next week,
Editor, Quant Trader
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