For short term trading, not much beats momentum, where a stock is on fire and we simply hop on for a short ride and jump back off. This is the life blood of short term holds whether it be a pre-earnings run, a split run, or a news driven pure momentum play. One of the biggest faults that can be made in this game is hanging on too long.
One often hears the phrase "I was up on ABC but now I’m down". The first question should be "why didn’t you sell when you were up?" The range of answers varies, but most often the answer is something like this "I was sure it would go higher, so I kept it. Then when it started to fade I figured it would just be temporary and it would run back up." Bingo! Therein lies the problem. If you have had the same story, we will ask you directly "when you were up, why didn’t you sell?" If your answer was because I thought it would go higher, that is fine, but when it started to weaken, Why did you not sell? This is the question that returns all kinds of sheepish replies, but the fact is we are emotional creatures and we like when our emotions are positive. When a stock is rising that we have actually purchased you can see the pride in people. They are smiling, their chest is out and their chin is up. This is natural because we did something and it is going our way. But too often in our zest to have that "good feeling" we make mistakes that cost us serious dollars.
Look at traders when they are in a winning trade versus a losing trade. When you are in a winning trade, you want to tell the world about it. We are social animals by nature and we like to show off a bit, and what better way than to say "Well, I bought ABC at 50 and its now 58"? The entire mind and body actually functions better. But what happens when we are in a losing trade? We tend to keep quiet. We don’t want to tell the world we just screwed up. We start reasoning with ourself that the stock we picked is a good one and if we just give it enough time it will come back. We sit a little lower, we slump at the shoulders, and we grumble over things that normally don’t bother us. In fact we suggest one of the reasons we don’t like to sell out of a losing trade is the subconscious humility involved with telling another human (your broker) we want to sell a losing position. So, that all being said, please, if you are up on a trade, take your money home. Do not let the stock fall and try and hope it back up. The way to do this is with stops, and if you cannot do or are uncomfortable with them, at least set mental stops and stay with them. For instance let's say we like ABC to move higher this week. We buy into it on Monday and pay 50 per share. Tuesday it is at 52. Wed. it is 52 ½. Thursday its 53. Friday the market sours and its now 49. If you still own it, you are now in a bad trade. The way to play this would have been to set stops. Remember we bought it at 50 and Tuesday it was 52. That is already a great trade, but we feel ABC has a lot of momentum in it and should move higher. So why not tell the broker we want to bail out if it drops to 50 ½? That gives the stock some wiggle room but still lets you make a small profit if it backs up. Now on Wed. we see its at 52 ½. Move your stop up to 51. Thursday it moved up to 53. Move your stop up even tighter so you keep more if it weakens, let's say 52. Now Friday comes and the market is pouting so as ABC is falling you trigger off and sell out at say 51 ¾. You bought at 50, and made 1 ¾. Sure it could be a temporary pull back and it could go higher. But it could fall like a rock. Either way you made a good trade! If when the market feels better ABC wants more, buy it again. But again use stops to protect yourself.
The use of a trailing stop is so simple that everyone should do it, and not too much is as effective as them at keeping you in a moving stock while limiting your downside. The bottom line to all this is simple. Do not be afraid to take your money off the table. It is much better to make 1 ¾ on something than to be trapped in something. You will never go broke making a profit, no matter how small it may appear. So, don’t swing for the fences, and if your trade starts to weaken, bail out while you have some of the market's money instead of hoping it comes up while they have yours!
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