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The One Thing Every Trader Should Do

I have a question for you…

Your answer may determine your prospects as a trader.

OK, here it is…

When do you sell a winning trade?

Take a moment to think this through. This is one of the most crucial questions in trading.

Many people can’t give an answer with conviction. For them, selling is an afterthought. All their energy goes into finding the perfect time to buy.

But here’s the thing: You don’t make money when you buy — you make it when you sell.

I’ve seen many traders come and go over the years. One of the leading reasons they fail is due to poor exits. Their mistake often comes down to one of two things:

  1. Cutting profitable trades too early; or
  2. Riding a stock up…then all the way back down.

For many, selling is the weakest part of their strategy.

Don’t worry if this applies to you. I have a strategy that could help. It’s the single best way I know to maximise your upside, while limiting your risk. I’ll tell you more in a moment.

But first, let me tell you a story. It will help reinforce why exits matter so much.

Triumph and tears

I remember talking to a trader — let’s call him Ted — in early 2009. The GFC had hit mining stocks hard. Many were trading at bargain-basement prices.

Ted was telling me about a stock he was buying. The company was iron ore miner Atlas Iron Ltd [ASX:AGO]. It was trading about 70% below its boom-time high.

Atlas had a compelling story. It had loads of cash and a low valuation. The shares were also turning higher after months of selling. I even bought a few for myself.

Ted was right — AGO took off. The shares rose by about 240% in two years.

I ran into Ted a few years later. After some short initial banter, I said: ‘How about Atlas Iron? You got that right!

Ted just looked at the ground. I knew instantly he hadn’t sold. He rode the boom, and then held on for an almighty bust.

AGO’s shares were worth just a few cents when I last saw Ted. Not having an exit strategy had cost him dearly. Ted’s stock was practically worthless.

You might be wondering about my shares. Well, my entry was at $1.35 in April 2009. The share price hit my trailing stop in December 2011, at $2.80. I did a bit better than doubling my money.

No, I didn’t get the high. I never do. That’s not how I trade.

I aim for the big chunk in the middle. That’s where I typically make the most money.

Quant Trader uses the same strategy. It’s not about buying at the low and selling at the high — no one consistently does that. The aim is to capture the big middle part of the trend.

Trading the trend

Last week’s update was about ‘bagging the elephant’. My aim was to get you thinking about triple-digit gains. These are entirely possible when you know how.

It’s now time to go a step further. I’m going to explain Quant Trader’s trailing-stop strategy. You’ll see how it can potentially turn a small profit into a massive one.

But first, let me refresh your memory…

[Click to enlarge]

You’ll recall this chart from last week. It shows a trade in Vita Group Ltd [ASX:VTG].

Now remember, this is a real example from Quant Trader’s live signals. You may have even had this in your portfolio. This is an excellent example of what’s possible when you ride a trend.

VTG had three entry points — $1.28, $1.42 and $1.65. Yes, these were good buying levels. But they are not the most important points on the chart.

The key to this trade is the exit strategy. This is what determines the size of the profit.

Look closely at the red line below the share price. It resembles a set of rising stairs. This is the trailing stop. And it can potentially turn your entries into a lot of money.

So, how can a trailing stop help?

Well, you might think VTG was a simple trade. The trend appears to rise steadily higher. Many people will say, with hindsight, that it’s easy to profit from this type of situation.

But they’re wrong.

You see, these big, sweeping moves can be deceptive. They mask a lot of corrections along the way.

VTG didn’t trade higher day after day. There were many pullbacks along the way. The six largest ones were 19%, 16%, 18%, 28%, 19% and 13%.

Corrections have a habit of shaking people out of their trades. Many would have sold during VTG’s pullbacks. They would have been left on the sidelines to watch their old shares soar.

A trailing stop can make all the difference.

Have another look at the chart…

[Click to enlarge]

You’ll notice the trailing stop ratchets higher with the share price. Quant Trader stays in the trade until the shares touch the red line.

People sometimes tell me that the trailing stop is always late to sell. And they’re right. VTG’s initial peak was at $5.10. Quant Trader’s exit was 25% below this, at $3.83.

But, you know what?

Being a late seller is often better than exiting early. The very reason Quant Trader got a 199% gain was because it was slow to sell — there was no temptation to lock in a small profit.

You’ll notice VTG recovered quickly after Quant Trader’s exit. This will happen at times. There’s no way to know what a stock will do after a trade ends.

Here’s the thing: Trailing stops don’t have laser precision. They do not mark a point where a stock will collapse. Many stocks recover after trading below their exit level.

And that’s OK.

A trailing stop has two aims…

  1. Keeping you in a trade for longer; and
  2. Protecting most of your capital when a trend appears to end.

Think of a trailing stop as a line in the sand. It can increase your odds of ‘bagging the elephant’, and get you out when the trend falters.

Sure, you won’t get the high. But you certainly won’t end up like my friend Ted!

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The Daily Reckoning's mission is to look at the investment world and the financial world in a sceptical and contrarian way. To do that day in and day out and tell you honestly what we see, even if it isn't always popular. If you'd like to subscribe to an alternative look at the mainstream interpretation of events, join for free here.



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