Anytime you invest in the stock market, you should have an exit strategy in mind before you make your buy. This means you need to set up your finish line before you start the race. Trouble is, in the stock market, the finish line keeps moving and you won’t know where it is until you’ve crossed it. If you think you can get a 20 percent return on your investment or even double your money – go for it. But why stop there? And what will you do if your stock drops?
If you were playing poker, you wouldn’t get up from the table after one or two winning hands would you? And if you’re smart you’ll know that when the cards are against you, it’s time to fold em and get up from the table before you lose your entire stake.
All too often, investors will sell their stock after 10 or 20 percent gains only to watch the stock go even higher. Yet those same investors will hold onto a losing stock until there is nothing left to worry about.
You can maximize your profits and minimize your losses when you use a trailing stop. Before I go any further with this, DO NOT use a market stop. Using a market stop is like showing the other players your hand in a high stakes poker game. I’ll show you a simple way to keep track of your trailing stops in a minute, but first, just what is a trailing stop and how will it help you?
A trailing stop is your moving finish line. When you cross it you sell. Simply set a fixed percentage below your stock price, 15 to 25 percent is typical, and if the closing price of your stock ever hits your stop, you sell it the next day.
I use a simple system to track my trailing stops. Take an index card and write down the stock symbol, the purchase price, the high and the trailing stop. Use pencil because each time your stock reaches a new high, you’ll change the high and trailing number.
Here’s why you never use a market stop. If I had used market stops, three of my trades would have stopped out during a particularly wild trading day during the recent market drop. The traders would have picked me off and I’d be out. I’m not because all three stocks ended the day above my stops and all three have been recovering nicely.
Had they closed at or below my stops, I would have sold out with decent profits in all three.
I’ve also learned the hard way that it’s far better to get out of a losing trade with a 25% loss. I hung onto one stock hoping it would get better. It didn’t and I lost more than 50 percent. I know I won’t let that happen again.
Trailing stops keep the emotion out of trading. You’ll never hang on to a loser (we all get them sometimes) and you’ll get the most out of your winners by letting them ride.