Buying a stock is easy.
Holding it is a little less easy.
Selling it? Well, that's the hard part.
Traders and investors usually fall into one of two camps:
1. They sell too early.
2. They sell too late.
Here's the truth. Virtually all of us fall into one of those camps. The thought that a third camp exists where someone sells perfectly isn't realistic. Instead, we live in a sliding scale of those two camps.
The emphasis in the descriptions of the two camps is on the word "too." How early or how late were you in selling? That's the fine line between success and failure, happiness and frustration, net profits and net losses.
So, long story short -- you aren't going to top tick your exits. That's fine. Accept it, and now never worry about it again.
What we do need to worry about is how you are going to determine exits, so here are a few methods I've found to increase your success.
1. Technical
Of course, those of you who know me knew I would go here first. If you use charts to help determine entries, then you probably already have a method to exit as well and may not realize it.
Flip the script. For instance, I like to use bullish crossover in the Full Stochastics indicator as an entry. I can turn that around and use the bearish crossover as my exit trigger.
2. Targets
Another approach we can use is target stops and target profits. For instance, on scalps, I like to use a 2, 4, 8 model. I sell one-third at a 2% gain, one-third at 4%, and one-third at 8%. I use the recent low as a stop as long as it is 4% or less; otherwise, I use 4%.
Each investor should tailor this to their own risk tolerance. A sub-approach to this is rather than scaling out as I presented, keep that last one-third position with a trailing stop rather than a hard 8%. Again, this is all about what works for your risk and goals.
3. Fundamentals
For buy-and-hold investors, what you own is often determined by the underlying business and/or valuations. The trigger to sell is simple here: when the story changes, sell.
Generally, we're talking about changing away from your thesis for the worse. For instance, if a company consistently paying a dividend must stop because cash flow goes red. Or a company's growth evaporates. Or a company's valuation runs so high that the price-to-growth or price-to-earnings no longer fits what you consider a buyable position.
4. Triggered Rebalance
If you have a set percentage in mind for your positions, you'll have to monitor their make-up in your portfolio. If your goal is each portfolio position to be 5%, then you would watch that number and put a "trigger" on it. For instance, if your trigger was an increase of 20%, then once the position hit 6% of your total portfolio, you would sell enough to bring it back to 5%. You could allocate that 1% into a position that became smaller or simply add a new position with the gains.
Within each of these four approaches are all kinds of tweaks or sub-approaches to the general approach, but traders and investors absolutely need to define how and when they sell before they enter a position.
An Additional Approach
There's another approach one could consider, something I believe is based on rationality, but it's the hardest for investors to implement. Each day, week, month, or whatever your normal time frame for investment, you should look at each position, ignoring your entry price, and ask yourself whether you would buy that position at the current level.
If you can't find a reason for buying that stock at that price, then why continue to hold it? You might think, well just because I wouldn't buy it here doesn't mean I shouldn't hold it, especially if I had a gain. The issue I have with this is if you wouldn't buy it at the current price, then somewhere in your mind that means you believe the downside risk outweighs the upside reward.
I'll admit there are other factors to consider, such as taxes, so it isn't a cut and dry system, but it is close. At the very least, it provides a starting point for you to debate adding, holding, or selling a position.
Unfortunately, it is easy to cheat on this approach by reasoning you would buy more, but you don't have the room in your portfolio to do so or it would overweight the stock. That may be a fair argument, but it is up to you to be honest with yourself on the question. After all, selling will require you to be honest with yourself, which may be the biggest challenge in trading and investing.
Sometimes we're wrong. It doesn't make you a bad person or even a bad trader, but when you can't be honest with yourself and adhere to a rule defining when to sell, you are going to find yourself holding onto a lot of positions without being able to explain why you own them.
Avoid that mistake and you'll be just fine over the long-term.
Tim Collins provides options trade ideas each day on Real Money Pro, our sister site for active traders. Click here to learn more and get great columns, commentary and trade ideas from Tim Collins, Mark Sebastian, Paul Price, Doug Kass, and others.
