Friday, January 13, 2012

Improving My Psychology of Selling Winners

I consistently struggle on how to deal with my winning stocks. One would think "WINNING!" (as Charlie Sheen put it) would be the most pleasant part of trading. Sometimes for me, it is the most challenging. When I have a winning position, unhelpful emotions begin to cloud my judgement. If I had to label the most potentially damaging of these, they would be greed, regret, and the prideful satisfaction of being "right". These very evil emotions have caused me to hold a gain too long and to not admit that the position, although I was right before, has run its course.

In order to address these unproductive feelings, let's talk about one particular step in the following list of actions I take during a successful trade:

  1. Planning the trade including stop loss estimation
  2. Buying the stock
  3. Setting the stop
  4. Watching the stock move in your favor
  5. Selling the stock

I want to break down #5. How do I know when to get out of stock?

The hardcore value investor looks for a specific target price when the "discount" no longer exists. The momentum trader looks for a significant change in momentum. A chart trader may look for violations of support or resistance. Some traders have decided on a gain ahead of time (in step #1 above) that would make them happy. Warren Buffet rarely sells unless his original investing premise completely changes or until full value is realized.

As I write this, I'm realizing why selling is the weakest part of my game. I have not really had a standard set of criteria that defines when I sell. I have always subscribed to the method of letting the stock "tell" me when the trend is changing. This usually means letting a 12% gainer turn into a 7% gainer before I take profits. Frequently this leads to feelings of regret because I am letting gains slip away. So, here is a brainstorm on how I can avoid these feelings of regret:

  1. In the planning stage, choose two targets. Target #1 would be prudent and realistic gains, whereas target #2 would be "ideal"
  2. Or, in the planning stage choose a single, flat, realistic target BEFORE the trade is initiated
  3. Let your winners run. Buy a great undervalued growth story, set a stop, let the stock run, and then move your stop to breakeven and never touch it again. This is how I would LOVE to roll, but I go back and forth on how realistic this strategy is. Chicago Sean wrote a piece dedicated to the idea here.

I will continue to research this, but please let me know your own methods of selling in the comment section below.

Happy Trading!

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