With the spectacular rally we’ve witnessed since March, many of you are sitting on big profits. And most of you are probably nervous about giving back those profits if the market turns back down.
If you’re unsure of when you should cash out, I can help.
Remember that where to take profits and where to place stop-losses are actually two interconnected issues.
Place your stop too tightly, and you run the risk of getting whipsawed out of a potentially lucrative trade. Place it too far away from your buy price, and you end up eroding away your trading capital.
Just as tricky is where to place your profit-taking stops. How do we stay with a winning trade for as long as possible while making sure that we don’t give up too much of our returns?
It’s a question that not too many people in the investment education community have successfully attempted to tackle. Most profit-taking is done on gut feel rather than on a measurable set of criteria.
There is no holy grail when it comes to optimizing profit-taking, but there are strategies that can help you catch much of the “meat” of the move.
Today I want to share two profit-taking strategies that you can start using right away on your winning stocks.
Taking Profits on a Larger Trend
Which profit-taking strategy you use depends on what kind of trader you are. Are you attempting to catch large trends that occur over weeks and months, or are you looking to bang in and out of the market in a period of days?
If you’re a trend-catcher, then you’ll want to give your positions room to breathe. One approach I like to use the 10- or 20-day low.
In a nutshell, I sell half of my position if the stock trades below the low of the last 10 trading days, and I’ll sell the other half if the stock trades below the low of the last 20 trading days ago.
Remember, I use this strategy after I have accumulated profits.
Here’s what the strategy looks like:
1. I place a trade with my standard stop-loss of a break below the most recent support level.
2. Assuming that I don’t get stopped out right away and my position starts to become profitable, I adjust my stop-loss to the low of 10 days ago … ONLY when that 10-day low is above the first stop price I used when I initiated the position.
(Remember it might take 20 days or more before the trailing 10-day low climbs above my entry price, and that’s assuming that my first stop-loss hasn’t been triggered in the interim.)
3. The first 10-day stop will typically be for my entire position.
4. When the low of the last trailing 20 trading days goes above (or meets) my cost basis, I adjust my stops so that, if the stock pulls back, I will sell half my stock at the 10-day stop and the other half at the 20-day stop.
5. Each new trading day, I adjust the level of my trailing 10- and 20-day stop levels.
Remember the above strategy is for longer-term trending types of situations.
This is by no means a perfect solution but, in a trending market, this approach will enable me to capture a large chunk of any meaningful move.
Cashing Out on a More-Aggressive Play
If I’m employing a highly speculative event-driven or news-driven play I’ll use a much more aggressive profit protector, one that I call the 2-day/4-day approach.
Again, for shorter-term trading, I will use a much shorter time frame. Instead of using the 10-day/20-day approach I’ll use the 2-day/4-day low as my profit exit point.
The 2-day/4-day approach is for very short-term trading strategies only and is designed for very fast-moving, momentum-type trades.
Remember: Pick the right tool for the right job; a big part of technical analysis is applying the correct strategy to the correct trading scenario. No one technical tool will work all the time with every single trading situation.
So, before applying a profit-taking strategy, be certain what type of trade you have on. Is it a long-term play for a major move? Or is it a short-term “hot momentum” play?
Here’s another quick tip I want to share with you.
Re-entering a Trade
Sometimes you can get bounced out of a great longer-term trend play, only to see the stock in question whip right back around and zoom higher.
This can be very frustrating if you don’t have a method for getting back into the trade in a way that you can live with.
There are two approaches I use when looking to re-enter a trade:
1. Buy back in on the next new high, with a stop-loss placed at the three-day low, or just below the most-recent support level. (Choose the stop that is closest to your entry price.)
2. Buy back in after the three-day Relative Strength Index (RSI) reverses up from 30 or below to above 50. Place your stop-loss at the three-day low.
Again, this isn’t the holy grail of trade re-entry, but it’s a very effective method for getting back into a winning stock.
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