Many people will tell you it’s easy…
They’ll say this action is the simplest part of a trade, and give it little thought.
But this mistake can cost you dearly. I believe it’s the number one reason that traders fail.
What action do you think this is?
Well, let me tell you…it’s selling. Of all the trading decisions you make, I believe this is the most vital. Getting this right can make you a lot of money.
But selling is easier said than done. Here are three classic mistakes:
- Holding losing trades too long
- Cutting profitable trades too early
- Riding a stock up…then all the way back down
It all seems obvious in hindsight. Why, then, do so many people get it wrong?
I’m going to show you an exit strategy in a moment. This method is ideal for capturing big share-price moves. It’s made me a lot of money over the years.
But first, let me tell you a story. This will help reinforce why exits are so important.
Buying is only half of a trade
I remember talking to a trader — let’s call him Ted — in early 2009. The GFC had hit mining stocks hard. Many were at rock-bottom 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 from the previous year.
The case for buying was compelling. 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 by chance a few years later. We had a short initial banter. I then said, ‘How about that Atlas Iron? You got that right!’
Ted just looked at the ground. I knew instantly he hadn’t sold. He rode the boom, then held on for the bust.
AGO was trading at about 14 cents. Ted’s stock was down close to 90% from his entry level. It was a disaster…he didn’t have an exit strategy.
You might be wondering how I went. Well, I bought at $1.35 in April 2009. My trailing stop got hit 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 you typically make the most money. And my exit strategy maximises the chances of doing this.
The key to making BIG money
Let me show you what I mean. The example you’re about to see is from Quant Trader — my system for trading ASX stocks.
Quant Trader uses a series of algorithms to calculate the exit level. The main input is a stock’s recent trading ranges. This makes it unique to each trade.
Have a look at the following chart. It’s for financial services company HUB24 Ltd [ASX:HUB].
Source: Quant Trader
[Click to enlarge]
This looks like an easy trade at first glance. It’s a nice, smooth upward trend that runs a long way.
You’ll notice the trailing stop…it’s the red line that ratchets higher with the share price. This is the selling point. You sell when the share price touches that line.
This is a big trend. The shares rally from $1.45 to a final exit price of $3.59. That’s a rise of 147%. (By the way, this is a real signal that members followed.)
People often ask why the trailing stop doesn’t rise faster. They want to know why Quant Trader doesn’t quickly move to lock in a profit.
This is a good question. Let me show you another chart. It shows what happens when I bring the trailing stop 50% closer. This is similar to how many people trade.
Source: Quant Trader
[Click to enlarge]
What a difference a tighter stop makes. It reduces a 147% gain to a modest profit of 9%.
This is why Quant Trader has a wide trailing stop. To ride big trends, you need to give the shares breathing space. That’s how you capture the big moves.
So forget about trying to hang on to every dollar of profit. Tight trailing stops usually result in relatively small gains.
You need to be willing to give some profit back. That’s how you stay on the stocks that double, treble, and more.
The trailing stop also makes sure you don’t end up like my friend Ted!
Until next week,
For Markets and Money