Tuesday, July 12, 2011
Forget about the "let your winners ride" philosophy that has been the mantra of so many successful investors over the years. This is a trader's market. It has been a trader's market for the past several months, if not the past few years.
Success and longevity as a trader does not come from making a killing on one big trade. It comes from cutting your losses short and consistently protecting and taking your profits.
Most people understand the importance of cutting losses short... You're going to have more losing trades than winning ones. So to succeed, you have to keep the losses small enough that one profitable trade can absorb the sting of several losing trades.
But people have a tough time grasping the importance of taking profits early. After all, you've done your homework, placed your bet, and the market is moving your way. Why not let it ride? Why not maximize your gain?
In a trader's market – one that waffles back and forth within a tight trading range – the action is condensed. Stocks don't move as much as they used to. Setups that used to yield triple-digit gains on options now reverse course after much smaller moves. So you have to be quicker about taking your money off the table, lest the profits you have today disappear tomorrow.
There is no greater sin in trading than to let a profitable trade turn into a loss.
"But what if it goes even higher?" the novice trader will ask.
In this market, who cares? Stock moves are temporary. It's better to sell a little too early, while there are eager buyers for your position, than to sell a little too late, when everyone is rushing for the exits.
Let me give you an example of what I'm talking about...
I turned modestly bullish on the market back in mid-June. At the time, I recommended my S&A Short Report subscribers purchase call options on Cisco Systems (CSCO) to take advantage of any rally. Any bounce in the stock market would cause CSCO to bounce as well, and the call options were cheap enough we could make as much as 300% on the trade if CSCO really got going.
The market rallied, and CSCO rallied as well. By early last week, we had an 80% profit on the trade. I told subscribers to sell.
In an uptrending market we would have held on to the trade. Cisco is a cheap stock. It's the 800-pound gorilla of the technology sector. It trades at just nine times earnings and pays a 1.5% dividend. Buying CSCO at these levels is an investor's dream.
But this is a trader's market.
By last Tuesday, the stock market was bumping up against the top of its trading range. Cisco was running into resistance on its chart. We had a good gain on our option trade – a gain that would disappear if the stock reversed lower.
So even though we were on the right side of the trade... even though CSCO was cheap... even though buying the stock was an investor's dream... we traded out of the position and locked in an 80% gain.
Today, CSCO is a little lower than where it was last week. That's enough to wipe out the gains on the option position. Had we held on to the trade, my subscribers would be breaking even right now. Instead, we sold "early" and kept a solid profit.
In a trending market, we can give profitable trades a little more room to run. But in the current environment, where stocks are ping-ponging back and forth and ultimately going nowhere, you must take profits early. It's the only way to succeed as a trader.
Best regards and good trading,
"As traders, we need to adjust our strategies based on how the market behaves," Jeff said last month. "The next time to buy will be when the S&P 500 either retests support near 1,260 or decisively pops above 1,296... whichever comes first." Get the details here: The Key Numbers to Watch in the Market Now.
Bank of America sinks to fresh two-year low.
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The euro breaks down to a three-month low on sovereign debt fears.
Uranium miner Bannerman Resources rockets more than 50% over the past week on Chinese bid to secure uranium supplies.