STRATEGY: Buying and Selling Stocks

There is more to being successful in the stock market than just correctly predicting whether a stock will rise or fall. I think a lot of people don't realize this. Correctly timing when to enter and when to exit might be the main factor in determining how successful you are in short-term trading.

Say you are about 80% sure that a stock will go up in the next couple of days. The next day, the stock drops 3%. That 20% uncertainty grows larger. Were you wrong? Should you get out now? What if the day after that, the price doesn't move? All sorts of emotions come into play, and it can really screw with your head. For a trader/investor, this is very very bad. Emotions cloud your logic and judgment, and you'll make decisions that you may regret later. I actually read an article not too long ago showing that people with brain damage in the areas responsible for emotion (the amygdala I think) turn out to be better investors than perfectly healthy people.

To fix this, you should always try to set rules for your trading and make them as objective as possible. When you first enter a trade, the first thing you should do is set a price at which you'll sell no matter what if the stock reaches this point. This is EXTREMELY important, and you MUST stick to this as often as you can; these "stop loss" prices will help limit your losses in case your prediction is wrong.

The second thing you should do is set some objective way of selling the stock for profits. I can think of two ways to do this (there could be more): setting a certain price or % gain target to sell at, or using trailing stops. Picking which one depends on the type of trader you are, but personally for myself I like the trailing stops more. Selling at % gains or certain price targets are good in that they will guarantee that gain as long as the price gets there. The disadvantage is that sometimes the price could get to within a percent of your target, but not reach it. You could also be missing out on more profits if the stock were to go up an additional 10% above your target price/percentage gain. Using trailing stops will capture the additional profit and also guarantee that you leave with at least a little profit, but since it trails, you will always be a bit short of the peak. If you can predict what price the stock will peak at, it may be best for you to just set a certain % or price to sell at. Here's a nice-looking picture I drew of the two sell methods.

So how do you pick price targets? Picking price targets is hard, and that depends on your analysis. You can base it on resistance points, or you can base it on trend levels, or you could base it on targets that come provided with chart patterns (a lot of chart patterns will have a price that it will expect to reach). You can always skip all of this guess work and use a trailing stop method as well.

Picking stop loss points may be even more important. These points, and how well you stick to them, are really what separates the successful traders from the crap investors. To pick them, you should always be aware of the risk/reward ratio. Everyone knows that you should always seek to find the stocks that have high reward with a low risk. However, with short-term trading, it is easy to forget this. For example, you might expect to get a nice 5% gain from a stock, but at the same time hold on to it if it were to drop 5%, thinking that it will eventually rebound. Instead, the ratios should always be greater than 1, and you should always be looking for setups that involve tiny risk. This would mean that your stop loss point, whatever it is, shouldn't be too far from the price it's at right now. Of course if it's too tiny, you'll end up getting stopped out of all your trades and you'll end up with more stopped losses than gains. However, if you time things right and use just the right set ups, it is possible to really keep your losses at a small amount. For example, here is an ascending triangle set up that I had mentioned previously, and the risk/reward ratio on it:

Knowing that the top of the triangle in an ascending right triangle set up is a key support line, you can set a stop loss point right below this. If the support here is blown, chances are it will continue to drop. With the entry at 26.1 on breakout and a 25.5 stop loss, you are risking 2.3% for a reward of greater than 15% (depending on what you set this at).

So that's the gist of it. There's two type of orders that can help you time your buy/sell points better, stop and limit orders. For selling for profits, limit orders are placed at a certain price and they'll sell when the stock hits this price or anything above it. For selling to stop your losses, stop orders will sell at a certain price or anything below it. For buying, limit orders are for buying at a certain price or lower (15, or anything lower than that for example), and stop orders are for buying at a certain price or anything higher.

Knowing buy and sell points are extremely important. I suck at this stuff, and although I think I can make pretty good calls on stocks, I usually always get screwed by either selling too soon with profits, or selling too late with losses. Because of this, my two or three bad calls have almost outweighed my six or seven good calls. So the lesson to learn from all of this is to make sure you set objective stop loss points!