Most traders think buying is the most important investment decision to make a long trade. But how you manage a profitable sale is arguably more important
Many traders punish themselves if they sell when a price keeps on rising after they have sold out. The bad feelings associated with regret that you sold too early are often worse than making a loss. That’s because they are accompanied by the emotions that you have missed out on a better gain or that you could or should have done better
What traders need to remember is that they are in the business of making money and not getting the last drop out of a profit is not the end of the world
One fact of life that traders must learn to accept is that it is quite normal to feel disappointment and to feel bad if you think you have missed out on a better gain
What is more important with trading, though, is having a plan with an exit strategy and with profit taking objectives.
Smart traders always sell for a partial profit if an investment price has risen substantially. That’s the time to cash in a third or a half of a position.
Selling too early: One of the most frequent investing mistakes - JOHN HEINZL
The first is that, unless a company is clearly broken, it is often prudent to hang on instead of bailing out.
“My findings show that two-thirds of the time investors will bank their profits when they have made up to 20 per cent,” Lee Freeman-Shor, a portfolio manager at London-based Old Mutual Global Investors, wrote in a recent blog post.
“While it may feel good, snatching at profits is a character trait (a habit) of a loser. In fact, I discovered that 61 per cent of investments that were sold for a profit of less than 20 per cent kept going up. Had the investor stayed invested, they would have made more money. Worse still, big winners were to be found among those [stocks that were sold].”
The second lesson I’ve learned is that, when mistakes happen, you have to accept them and move on.
One strategy employed by some momentum traders, such as Louis Navellier, is to stay nearly fully invested at all times. They will sell a stock only when they find a replacement that they think is better. That approach forces them to hold onto positions and not to give into the natural impulse to take a gain just to be doing something. Their mantra is that there is always a bull market in something.
To effectively address the issue of taking profits too quickly, we have to consider what drives us to do it.
For some traders, booking a profit is tangible proof of success. We feel good when we realize a gain and tend to want to do it regularly and frequently. Unrealized gains just don't provide the same level of satisfaction
One way to combat the inclination to be busy is to make partial sells and buys. Don't sell your whole position.
Simple self-awareness is the best way to deal with premature selling. You have to be prepared to ask yourself exactly why are making this move. Do you have a plan for the cash? Do you think this is a major top? Are you looking for reentry at a lower price?
It is when the present value of a future income stream (intrinsic value) is ignored and ‘investing’ is replaced with uninformed speculation about (unjustified) price increases that we should be most concerned.
I am suggesting that current valuations in Australia are not justified by near-term economic conditions, and more importantly, prospects for profit growth.
It does not follow that overvaluation is immediately followed by a crash. However, flying in the face of conventional wisdom, it pays to be more cautious because real risks are higher than perceived risks.
At the end of May 2017, the average PE for the group of Australian companies mapped was 18 times.
Worryingly, growth in forecast earnings has contributed just 19% of the appreciation in stock prices over the last five years.
Fully 81% of the market’s performance over the last five years has simply been due to PE expansion, that is, investors’ willingness to pay more for the same dollar of profits.
If the outlook for longer-term earnings growth has improved materially over the same period, such optimism might be warranted. However, like many of our wealthy and experienced business and entrepreneur clients, we see darker tinges to the clouds forming on the horizon.
The average PE today is 7% higher than at the end of October 2007, the pre-GFC peak. Additionally, there are parallels to that period with global interest rates starting to rise following a period of aggressively accommodative monetary policy, and record high levels of debt in the Australian household sector.
The big difference for Australia this time however is that a slowing China, and contracting investment in resources sector capacity growth, will fail to rescue the Australian economy from any broader economic slowdown.
Prior to the GFC, forecast earnings growth was 10% higher than the prior corresponding period, underpinning the PE ratios investors were willing to pay.
Today, not only is the market paying 7% more for each dollar of earnings than it was prior to the GFC, but earnings forecasts are only 3% higher than the same time a year ago.
It follows that caution may well be premature but it is nevertheless well founded because the higher the price you pay, the lower your returns and locking in low returns is in nobody’s interest.
#1: AVOID THE “TO GET THE MONEY BACK” MINDSET.As you want to “get it back”, you set your targets based on the amount you want to get back. That will get you in trouble because that’s not in sync with the market price action.
#2: PAY ATTENTION TO VOLUME CLIMAXES. Look for climatic volume. Extremely high volume price bars or swings are always critical in market analysis. One practical way to use this knowledge is to exit with high volume. If you need a technical method to judge, use Bollinger Bands applied on volume bars.
#3: DON’T TRADE EVERY DAY.
#4: PROTECT YOUR TRADING CAPITAL. Take only the best trades. It also means limiting your position size, so that no streak of losses can wipe you out.
#5: DON’T LISTEN TO OPINIONS
#6: PROCESS OVER OUTCOME. In a game of probability, you cannot control each and every outcome. What you can control is the process. As long as the process is controlled, over time, statistics will prevail.
#7: NEVER SAY NEVER. The problem with “never” is the risk attitude it encourages. When you think that the market will never do something, you feel that you can never lose
#8: PROTECT YOUR MENTAL CAPITAL. Mental capital is what you need in your mind. Think confidence, peace, and focus. Not fear, doubt, and impatience. Nothing saps mental capital like a big fat loss. Manage your risk exposure carefully. Nothing improves your mental capital like winning trades that come from your trading rules
#9: TALK YOURSELF OUT OF BAD TRADES
#10: BREAK RULES, SPARINGLY
When should you hold more cash? The simple answer is: when fewer people are holding it. Because that’s when it’s most valuable.
And, right now, after the stampede to other asset classes, cash is more valuable than it has been for some time.
When central banks around the world acted collectively to drive short term interest rates to zero and then to flatten the yield curve by also buying global long term bonds, they triggered a mass migration of investors out of cash and into every other asset class.
As billionaire Sam Zell once observed, liquidity is value. Only when you can actually sell is the value you have put on your asset correct. In a market full of investors trying to exit, market values will change suddenly.
So ask yourself: if I need to get out in a hurry, will I be able?
If you aren’t leveraged and you don’t mind riding a cycle or two, you have little to worry about. And if you have another income stream that allows you to add to your portfolio at lower prices, again you have little to worry about.
But cash is most valuable when nobody has any. And given the migration that drove asset prices higher, few have any. If there’s a migration back to cash, illiquidity could trigger a significant fall in asset prices.
The most important lesson in technical trading is that there are 2 basic kinds of markets
(1) a Trending market.
(2) a Range-bound market.
Knowing which type of market you're in at any given time is the secret to successful trading.
Why? Because the type of market you're in dictates the type of indicator you use.
2 basic types of indicators:
(1) Oscillators indicators
Oscillators are reversal oriented. They are designed to spot points in time when a market is overbought or oversold, and due for a reversal. In other words, they indicate points in time when a market move has probably exhausted itself and is ready to turn the other way.
Oscillators are great tools in a range-trading environment, characterized by short-lived swings (sometimes on the order of days) and quick reversals. Which oscillators have we used with success? Stochastics, Wilder's Relative Strength Index, and Wilder's parabolic SAR
(2) Momentum indicators
Trend indicators seek to spot momentum, and are continuation-oriented.Their assumption is that a strong trend will continue, and you should trade with the trend.
Tools such as MACD, ADX/DMI, and moving average crossovers are more apt to give good signals in a trending (momentum) environment
A trend will either continue, or it will reverse - but it can't do both! By default, when one type of indicator works, the other one will not.
The movement of price bars will tell you what indicator to use. If you see an index moving back and forth in a narrow range, use an oscillator. If you see a stock moving an a straight line and breaking above or below previous highs or lows, that's a trend that should be spotted by a momentum indicator.
In the history of capitalism, this is the hardest time ever to invest. People are going broke, losing their jobs, and fear more than greed rules the news and tries to rule thoughts.
In short: people are scared. And I do think the uncertainty is going to rise quickly so I wanted to put this note together.
The most important three words in investing is: “I don’t know.” If someone doesn’t say that to you then they are lying.
I’ve learned one major thing, which I will repeat below: all of Wall Street is a scam.
A) Should I daytrade?
B) I don’t believe you. Many people daytrade for a living.
C) Well, who makes money in the market then?
Three types of people:
People who hold stocks forever. Think: Warren Buffett (has never sold a share of Berkshire Hathaway since 1967) or Bill Gates (he sells shares but for 20 years basically held onto his MSFT stock).
People who hold stocks for a millionth of a second (see Michael Lewis’s book “Flash Boys” which I highly recommend.) This is borderline illegal and I don’t recommend it.
People who cheat.
D) So how can one make money in the market? I told you about: #1. Pick some stocks and hold them forever
E) What stocks should I hold?
Warren Buffett take over here. He says, “If you think a company will be around 20 years from now then it is probably a good buy right now.”
I would add to that, based on what Warren does. It seems to me he has 5 criteria:
A company will be around 20 years from now.
At some point, company’s management has demonstrated in some way that they are honest, good people. If you can get to know management even better.
The company’s stock has crashed for some reason (think American Express in early 60s, which he loaded up on. Or Washington Post in the early 70s. Or Coca-Cola in the early 80s).
The company’s name is a strong brand: American Express, Coke, Disney, etc.
Demographics play a strong role. Especially if you can get into a rising demographic through the backdoor. I explain exactly how here.
G) Should I put all of my money in stocks?
No, because you’ll never know anything about a company and you won’t get the kind of deals that Warren Buffett gets.
So use this guideline:
no more than 3% of your portfolio in any one stock. But if the stock grows past 3% you can keep it. To quote Warren Buffett again: “If you have Lebron James on your team, you don’t trade him away.”
no more than 30% of your portfolio in stocks (unless some of the stocks grow, in which case you just keep letting them grow).
G, Part 2) What is in a bubble?
So ignore cycles and bubbles and ups and downs.
And never ever read the news. The news has no idea about the financial world and what makes it tick. Any investing off the news is like taking out your eyes because you trust a blind person to drive you to work.
M) What are some good demographic trends?
The internet. Yes, it’s still growing.
Baby boomers retiring. They need special facilities to live in. They need better cancer diagnostics and treatments.
Energy. The more people we have, the more energy we will consume. Go for energy sources that are profitable and don’t need government subsidies. Whenever you depend on the government, you could get in trouble.
Temp staffing. Every company is firing people and replacing them with temp staffers.
Batteries. If you can figure out how to invest in Lithium, then go for it. I explain easy ways to invest in demographic trends that in ways other people aren’t looking in my Backdoor Investing Checklist.
O) If no housing and only 30% of my portfolio in stocks, then what should I do with the rest of my money? Cash is a beautiful thing to have. You can pay for all of your basic needs with it.
P) What does that mean, “invest in myself?”
It costs almost nothing to start a business. Find something people want and start posting information about it on a blog and then upsell your services on the blog.Or write 1000 small books about different topics and publish them on Amazon. You can do this on the side while you learn and have a full time job and then when you are ready, you can jump to your other passive streams of income. I have a podcast coming up soon with a guy who makes $25,000 a month doing this. Note: It takes a lot of work to find “passive” income but when it happens, it’s worth it. These are some ideas. There are many others.
Invest in experiences rather than possessions. Figure out interesting and unique experiences you can have or places you can go to (but they don’t always have to be places). Experiences pay much higher dividends than an extra TV or a nicer car.
Reading is the best return on investment. You have to live your entire life in order to know one life.But with reading you can know 1000s of people’s lives for almost no cost. What a great return!
R) What else should I do with my money?
Money is just a side effect of health.
Here’s the whole thing: stay physically healthy in whatever way you know how (sleep well, eat well, exercise). Be around good people who love you and respect you and who you love and respect, and be grateful every day.
Think of new things each day (or all day) to be grateful for. “Gratitude” is another word for “Abundance” because the things you are most grateful for, become abundant in your life.
And finally, write down 10-20 bad ideas a day. Or good ideas. It doesn’t matter. After exercising my idea muscle for six months, I felt like an idea machine. It was like a super power that just wouldn’t stop. Money and abundance in your life is a natural side effect of the above. I know this for myself but now since writing about it for almost four years I can tell you from the letters I get that it works for others.
You can always make money back when you’ve lost it.But one single split moment of stress and anxiety you will never make back again.