Selling at a target

You buy a stock when you expect it to rise. If you thought you could get it cheaper, you would have waited to buy it at a lower price later.

Once you select a buy candidate, you need to ask several questions:

1. What do you think the profit target is—how high is this stock likely to rise?
2. How low does it need to fall to convince you that your decision to buy was incorrect and the time has come to cut losses?
3. What is this stock’s reward-to-risk ratio, meaning what is the relationship between its potential reward and risk?

Professional traders always ask these three questions. Gamblers do not bother with a single one.

Let us begin by tackling the first question: What is the stock’s profit target?

A good way to set a target for a swing trade is to use either a moving average or a channel. A good way to estimate a profit target for a long-term trade is to look at long-term support and resistance.

Putting on a trade is like jumping into a fast-moving river. You can walk up and down the shore, looking for a spot to jump in. Some people spend a lifetime on the shore, paper-trading their way through life. You are safe on the shore: your skin is dry and your cash is earning interest in a money market account. One of the very few things in trading you can totally control is the moment you decide to jump in. Do not allow restlessness or anxiety to push you in sooner than you need to, before you find a good spot.

While you are on the shore looking for a place to jump in, there is another important area to scout. You must look downstream, where the current rips over boulders, creating rapids. You need to scan the distant shore for what may be a good place to get out of the water. You must set up a profit target for your trade.

Decades ago, when I first began to trade, I had the misguided notion that I was going to get into a trade and get out when “the time was right.” I was afraid to set a profit target because that would reduce my potential profit. An amateur who gets into a trade with no clear idea of a profit target is pretty certain to become confused and lose his bearings. Not surprisingly, there was very little profit for me in those days, but no shortage of losses.

Kerry Lovvorn hit the nail on the head when he said during his interview for Entries & Exits: “People want to make money but do not know what they want from the markets. If I am making a trade, what am I expecting of it? You take a job—you know what your wages and benefits are going to be, what you’re going to be paid for that job. Having a profit target works better for me, although sometimes it leads to selling too soon.”

In this chapter I will show you several trades from my diary, including an entry, an exit, and a follow-up. Since this is a chapter about selling, I will focus on the exits from long trades, while covering the entries just enough to provide a general idea of the reasons for a trade.

Before we begin, let me comment on the follow-up charts in this book. Some of them may look impressive, with my exit nailing the top, but often you’ll see that more money was left on the table than taken from it.

Beginners who look at charts are often mesmerized by powerful trends. Experienced traders know that big trends look clear only in retrospect. All trades are perfectly visible in the rearview mirror, but the future is vague, changeable, and unclear. Putting on a trade is like riding a wild bronco at a rodeo. As you shoot out of the gate, you know that if you can stay on horseback for 50 seconds you’ll be considered a very good rider and earn a prize. The time to ride a long distance will come later and on a different horse. We will discuss selling long-term positions later in this chapter.

As you look at these trades, most of which come from my personal trading diary, please pay attention to several features. Notice that I grade every trade in three ways—for the quality of my entry and exit and, most importantly, for the overall quality of the trade. I always write down my source for the trade idea. It can be my own homework, a Spike pick, or something from a webinar. I have cells in my record-keeping spreadsheet that trace a total P&L for every source of ideas, for obvious reasons. I want to know who to listen to in the future and who to ignore.

Now we are ready to begin setting profit targets. Let us discuss the tools available to us. My favorites are:

1. Moving averages
2. Envelopes or channels
3. Support and resistance zones
4. Other methods

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