within our monitored “portfolio” where we are either buying a stock position
for the very first time, or coming back to a stock that has not been
bought and sold in a considerable amount of time. Actually, most of our
purchases do not involve even the simple process described above, as in
the majority of our trades we “ride the ripples.” Before we look at what
that technique involves, however, this is an opportune time to look at the
other side of the buy signal coin and examine the issue of when to sell.
In many “how-to” investing books, the authors give as much space to
the sell decision as they do to the buy decision. The guru guide offers an
insight into the signals that indicate that the upward trend of the chosen
stock has run its course and now a red light is flashing telling us to sell,
sell, sell! Another common approach states that you should ride your profits
and quickly take your losses—often through the disciplined placing of
stop-loss orders—one that has indeed become something of a classical approach
to the issue of selling in short-term trading strategies. Clearly this
is an approach that has merit, as it quickly separates the winners from the
losers and by backing the former and cutting the latter seeks to give predominance
to the winning trades. Should the strategy work, it will cover
the costs of the losers as well as make an overall trading profit. While this
is a perfectly valid approach to short-term trading, its rigorous application
would be counterproductive when tied to our practice of buying shares
that are trending down with our implicit acceptance that the downward
trend may continue for a little time before reversing. To our mind, given
our contrarian approach, quickly cutting losses would necessarily result in
too many positions being sold as losers, to the extent that it would be impossible
to make enough profit from those that immediately bounce back
and score gains. Equally, given that it is our practice to buy stocks when
they are relatively close to the lows of their 52-week range, we feel that patience
and expectation of their recovery over time makes the best sense for
us for those that continue to decline afterward. Our results in Appendixes
A through C bear this out. In conclusion then, the buy signals that we
use for targeting our purchases make our trading method essentially incompatible
with the popularly advocated strategy of riding winners and
cutting losers.
Moreover, as our trading technique seeks to allow us to take advantage
of the short-term fluctuations that we see in stocks over a period mostly of
just a few days, we do wish to ensure that we take our profits quickly on
those positions that go up, in order hopefully to be able to take advantage
of a downdraft coming as part of the normal ripple fluctuation of markets
and the individual stocks within it. So we ride the ripples, not our profits,
which we discuss in the next section of this chapter.
The sell strategy we follow has the advantage of being the simplest
part of our short-term trading method and is encapsulated in the following
simple rule: You sell when you make a predetermined profit. During most
of 2005, we stood ready to sell once the profit on any stock that we had
bought reached $40 net of brokerage commissions. Late in 2005, for all of
2006 and into 2007, we switched this number to $50 except for stocks that
we were selling on the same day that we had bought them, in which case
we sold them at the $40 minimum. There is no hard or fast rule on the actual
amount that a trader following our strategy may use. However, if you
choose to utilize our short-term trading strategy, you do need to have the
ability to follow your preset selling discipline with determination, as it is
the only way in which you can earn profits from repeat ripple fluctuation
trading described later in this chapter. With our quick-fire approach to selling,
a stock often continues to rise in price after we have sold, as we are
by definition selling during a climbing trend, at least as far as that stock
is concerned. We do not lament over any additional price rise forgone. It
may be difficult for many not to obsess about how much money could have
been made if one had just waited a little longer. A good example of this is
demonstrated by what happened with Catalina Marketing mentioned earlier
in this chapter. But remember that the stock could easily have turned
down again without any profit having been made. Indeed our trading strategy
is predicated on the observation that over the very short term stocks
do tend to fluctuate in price, rather than making a strong unwavering move
either upward or downward. In any case, it helps to recall the old trading
adage, “Nobody ever went broke taking a profit.”
The astute reader, after looking at Appendixes A through C, might ask
why, if we target a $40 or $50 profit figure, we made profits on some trades
in the hundreds of dollars and very often far in excess of our minimum
profit requirement—as much as $993 on a 14-day position in MBNA Corp.
and $879 on a four-day position in Genentech, both in 2005; and $651 on
a 25-day position in Adobe Systems in 2006. The answer is that as amateur
traders who have day jobs, we only get the opportunity to look at our
positions from time to time during the day (and some days we have more
time to devote to monitoring our “portfolio” than others). While we have a
threshold profit figure and allow ourselves to be guided by it, in many cases
when we look at where our positions are, we have already scored a much
higher profit. This is certainly an added bonus for us. Notice that we do not
place limit orders to have stocks sell as soon as they reach our required
margin of profit. While we do like the discipline of following a profit margin
strategy which will cause us to sell if we check our open positions and
find that one or more have reached the target, we find that the leaving of a
certain element of flexibility in selling often results in our making some additional
money because the stock price can often blow through our target
price. This is especially true if, as in the case of MBNA mentioned above,
the stock has benefited from a takeover bid from another company—Bank
of America, in this particular case. This notwithstanding, it is an important
element of our strategy that the necessary discipline is always there
to sell unquestioningly and without hesitation when we do check the price
and see that we have broken through the sell signal level.
As mentioned earlier, in those cases where we have purchased a position
in a stock, a continuing decline in the price of the stock often motivates
us to buy a second position at lower levels. Note, however, that where we
come to sell the second position bought at lower levels, the criteria used
are based on the same profit margin target over purchase price as applies
to any of our trades—so we are not engaging in “dollar-cost averaging.”
Dollar-cost averaging involves increasing positions in a stock already held,
but made at a lower cost level so that the average cost of the entire position
in that stock is lowered. Typically with a dollar-cost averaging strategy the
entire position would be sold at a profit calculated on the average cost of
the position overall. With our method, however, every distinct purchase is
sold at our predetermined profit margin, or held until that level is attained.
It should be noted that our method of selling the last stock purchases
rather than the first is known as a last in, first out (LIFO) approach.
When tax time comes around, this is the way trades need to be reported
for this method to work without a great deal of additional complication.
Although the most common way for multiple trades in the same stock to
be reported to the IRS is on a first in, first out (FIFO) basis, the IRS allows
LIFO accounting of trades as long as the approach is consistent throughout
the filing.
Read More : When To Sell ?
