Monday, April 5, 2010
The trade sounded too good to be true.
The mega-rich Chinese government, ensuring the success of a few small gold and silver stocks?
Almost everyone likes a good "China story," and almost everyone likes a good "gold mining story." Put the two together and you've got a heck of a story.
This story was all my colleague Matt Badiali, editor of the commodity-focused S&A Resource Report, could talk about for several weeks last year. He encouraged anyone who would listen to buy several mining stocks operating in China and favored by the Chinese government.
The results of Matt's research have been extraordinary. One of his top picks, Jinshan Gold Mines, is up more than 450% from his original recommendation in July...
I'm telling not telling you to gloat about my firm's stock picks, however. You see, with the stock market up 76% from its March 2009 low, and with many stocks like Jinshan up hundreds of percent, it's tempting to forget about a crucial component to winning in the stock market.
It's tempting to forget about how you'll sell a winning stock.
After all, most people can't help but get attached to a stock that has performed so well. They feel like they'd be selling off the family dog.
You can't take that approach to trading stocks. You can't treat stocks like loyal pets. You can't fall in love with a stock. No stock will ever love you back.
It's precisely when a speculative position is treating you well that you must start planning on getting rid of it. When a speculative position is up 200% or 300%, you must remember your exit plan... or even alter it.
When Matt recommended Jinshan, he placed a protective 50% stop loss on the position. Fifty percent is a wide stop loss... one typically only used on volatile mining or biotech stocks. It's a smart stop to use when you initiate a position in a speculative stock... It gives your trade plenty of "rope" to work in your favor.
But consider someone who bought $10,000 worth of Jinshan on Matt's original recommendation...
This trader's stake is now worth $55,327. He's sitting on more than $40,000 in profit. Keeping that original 50% stop loss on the position is keeping a big chunk of money at risk.
If the stock market were to decline big, a 50% stop on this position would result in a sell order triggered when the position was worth $27,663. You'd be exiting the position with "only" $17,663 in profit.
But let's say you "tightened" your stop to 15%. This means you'd sell the position if it declined just 15% from its closing high, rather than 50%. Using a 15% stop, you'd exit the position when it fell to $47,027. This preserves a profit of $37,027 on the position. As you can see, this is an extraordinary difference.
Granted, tightening your stop to 15% will increase the chances of you getting stopped out of the position. But if you feel the position is fully valued... or if you're concerned about the likelihood of a substantial general market correction, it's worth considering. It can make for a large difference in profit.
If you have some extraordinary winners that you added to your portfolio last year, take a close look at their valuations. Has the big market run made them overvalued? Could they suffer a 30%... 40%... or even 50% decline if investors got spooked about the giant debt problems most Western governments face? If the answer is yes, consider tightening your trailing stops. As we've seen, the difference can be many thousands of dollars.
Health care giant Johnson & Johnson climbs to fresh highs... up 10% since November.
New highs for Canadian stocks... fund EWC up double digits in two months.
Big fast food gains... McDonald's and Yum Brands (KFC, Taco Bell) make new highs.