The 'Sell Decision' Is Paramount

 | Apr 27, 2013 | 12:00 PM EDT
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It is often said that successful trading is a simple matter of cutting losses and letting profits run. That logic is irrefutable, but like most advice, the challenge is the actual implementation of the general concept. It is easy to state the rule but quite difficult to actually live it.

One of the ironies about stock market advice is that the vast majority of it is focused on the buy decision. I would guess that at least 90% of the stories about stocks are about which ones you should buy.

Based on that, you might think the main thing that determines investing and trading success is buying the right stock. While that is extremely helpful, the sell decision influences your success to a much greater degree. Anyone can buy and hold a stock, but the ability to cut losses and take gains makes the big difference. We all know of people who made a lot of money buying great stocks but then they gave it all back because they had no idea how to sell.

Selling boils down to two basic approaches: trailing stops or selling into strength. Each has its advantages and disadvantages, and what works best depends on the overall market action, the nature of the stock and your style of trading.

The trailing stop is probably the most common method used by traders. You set a price level maybe 7% to 10% below the current price and keep on moving it up as the stock runs. This works great in a strong market with trending stocks. As long as there isn't any great volatility along the way, you keep building your profits, then exit and lock them in when the turn finally occurs.

LinkedIn (LNKD) is a good example of how that would have worked quite well if you bought the stock following its very strong fourth-quarter report. There was one slight pullback in early April but if you used a loose trailing stop, you could easily have ridden this trade 20 to 40 points.

The other approach is to sell into strength. This works best when conditions are choppy and stocks are volatile. If stocks are moving around quite a bit, a trailing stop doesn't provide much profit potential. If you set them too tightly you will be quickly stopped out, and if you set them too loosely then you increase your risk of big losses.

Selling into strength allows you to lock in profits and maybe give it another try as the stock moves around. The big risk is that the stock will start to trend and you will be left behind, but more often than not stocks will give you numerous opportunities to re-enter.

A good example of a stock where selling into strength works well is Amazon (AMZN). If you sold into the spikes as they hit resistance, you had a good opportunity each time to rebuy at lower prices and trade it again.

You can never know for sure which approach to selling will work the best. It changes all the time as the market action changes, and it will vary with each stock that you trade. I find that it works well to use a mixed approach. I'll take some partial profits into strength but hold a portion of my shares with a trailing stop. If the stock continues to run, I may wish that I held on to more, but taking partial profits assures me a good return in the event that a trade suddenly turns south.

I've only scratched the surface of the sell decision, but probably the most important point I can make is that you must have a strategy. The biggest mistake people make is that they buy a stock and then have no plan on what they will do as it moves up and down. At a bare minimum set a loose trailing stop and keep in mind that just because they're stopped out, it doesn't mean they can't buy the stock again. The important thing is to limit losses in a systematic manner.

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