Five Ways to Consistently Bank Gains and Manage Winning Trades

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Most investors become so focused on their losers that they have no idea how their winners are performing…until they become losers and start paying attention to them.

As far as I am concerned, that's bass-ackward.

What they should be doing is figuring out how to harvest their winners, especially now that the six-week rally we've enjoyed appears to be losing steam.

If you've been raised under the old axiom of "cut your losses and let your winners run," this may seem counterintuitive.

But, if you really want to succeed in today's markets, you have to consistently sell your winners. That way, you continually cycle your capital into brand new opportunities.

It's not much different than what regularly happens in the produce department at the grocery store. Places like Safeway Inc. (NYSE: SWY) always replenish the tomatoes and the like to keep them fresh.

You should do the same with the "inventory" in your portfolio because if you let your stocks sit on the shelf too long, they'll eventually go badjust like fruit that's past its expiration date.

Here are some of my favorite tactics to help you lock in profits instead of letting irrational behavior and emotion take over when the markets suddenly have a mind of their own.

    1.) Recognize every day is a new day

This one is very simple. If the original reasons why you bought something are no longer true, ditch it – win, lose or draw.

You can't risk falling in love with your assets any more than you can let them rust – yet that's exactly what most investors do. They buy something then assume that it will somehow plod along on autopilot.

This is a variation of what I call the "greater fool theory" as in some greater fool is going to come along at a yet-to-be-determined point in the future and pay you more for a given investment than you paid to buy it.

I can't imagine what these folks are thinking.

Today, more than ever, you've got to continually re-evaluate your investments to ensure that they stand on their own merits and are worth the risk of continued ownership.

    2.) Sell into Strength

Most investors have been taught to let their winners run. I'm all for that – don't get me wrong – but ask yourself why the professionals take money off the table whenever they've got winners on their hands.

Answer – they know that the longer a bull runs, the higher the odds of a reversal.

That's why they begin "lightening up" or systematically selling positions or even portions of positions when prices are rising. We use the same philosophy at Money Map Press.

Investors who have grown used to the "set it and forget it" approach typically don't like this method. They argue that they will leave money on the table if something keeps going up.

Of course, they're absolutely correct. Selling prematurely can lead to reduced profits.

But what I am talking about has nothing to do with selling early. In today's markets, I think it's far more important to recognize that systematic selling when the markets are rising and liquidity is high helps you a) lock in profits before a reversal arrives and b) reduces the potential for future losses.

And if the markets continue to rally?

That's a logical question I get all the time. My response is always the same…so what.

If a rally has legs, there's nothing stopping you from redeploying your gains into new opportunities. Hopefully, you'll be smart enough to manage those, too.

    3.) Use trailing stops

This sounds pretty self-explanatory but you'd be amazed at how many people I talk with every year that don't use them, despite the fact that most brokerages and online trading platforms have these features built in and available for free.

Trailing stops, in case you are not familiar with them, are essentially price targets that work in reverse.

They are typically calculated as a percentage of purchase price. For instance, a 25% trailing stop on Apple at $657.41 is $493.06. If the stock dropped to $493.06, the order would execute and carry you out of the trade.

Variations include specific dollar-based stop losses, calendar stops and contingency orders – all of which typically rise in lock step as the price of your investment rises.

What I like about trailing stops is that they offer an unemotional, unbiased exit path when any investment begins to move against you. But that's the catch. You have to give up some ground before you're carried out of the trade.

As is the case with any investment strategy, there are people who don't like trailing stops because they get bounced out of trades that seem to immediately turn around and head higher without them.

I can't say I blame them. Floor traders, hyperactive day traders and quants with computers that would make NASA envious love to "shake the monkeys" from the trees and "run the stops." Both are euphemisms for deliberate actions intended to exploit the protective actions of others for gain.

It doesn't bother me most of the time because I have an investor's mentality. Therefore the daily volatility associated with this kind of gamesmanship is just noise and hitting the occasional stop is just part of the game.

If I am day trading, that's another matter entirely – and a subject for another time because setting trailing stops in a day-trading environment is a discipline all its own.

    4.) Buy put options

Buying put options is a more sophisticated variation of a trailing stop that gives those who use it more control over the sales process. The drawback is that the cost of your investment goes up because you're effectively buying "insurance" against a loss.

For instance, if you bought 100 shares of Facebook today at $20 and wanted to limit your losses to 25% of your purchase price, you could place a trailing stop at $15 a share. Your initial investment would be $2,000 (ignoring commissions and fees for the sake of simplicity) and you'd be selling your shares automatically if the stock dropped to that point.

Or, you could buy 100 shares of Facebook today at $20 and simultaneously purchase a November $15 put for $0.70. Your initial investment would then be $2,000 plus the cost of the option or $2,070 (again ignoring fees and commissions).

As the price of Facebook shares drop, the price of the put option you've purchased goes up, helping offset the loss you would otherwise be incurring. If shares of Facebook rise, the value of the put option generally drops.

If Facebook is trading above $15 on November 16, 2012 when the put option in this example expires, you lose the $70 and you'll have to buy another put option to "protect" your investment further, which means your cost basis goes up again.

If Facebook is trading below $15 on November 16, 2012, the option goes "in the money" and helps limit your loss to the difference between your purchase price of $20 and the strike price of the put option which, in this case, is $15 (excluding fees and commissions for simplicity's sake).

On a related note, some people like to sell call options against their stock as a means of offsetting losses incurred as a stock drops.

While I can understand the merits of doing so, I'm not a big fan of this strategy because it's very hard to sell enough options over time to pay for the loss associated with a given investment particularly if there's a catastrophic move to the downside, especially under current market conditions.

    5.) Set profit targets

I've saved the best for last. It's setting simple profit targets.

Like trailing stops, profit targets are usually set in percentage or dollar terms.

I'm a big fan of profit targets because they offer an unemotional path out of the market and ensure discipline no matter how emotionally attached I become to a particular investment.

Unlike many investors who constantly shoot for the moon, I don't see the need to be greedy. Depending on my expectations and market outlook, I'll set realistic profit targets that can vary widely.

For conservative choices, 10% over a few months might be good. For more aggressive recommendations, banking more than 100% in only a few weeks or even days may be appropriate.

Either way, if and when an investment hits my price target, I'll sell with no questions asked and bank the gains. I almost never look back.

Many investors like to think they'll do this but, in reality, find that they get sucked into the moment because they confuse the potential of additional upside with very real need to manage the risks associated with staying in the game longer than they have to.

You might think this is not a big deal. I beg to differ – any time you attempt to second guess the markets you are, in effect, introducing a timing element into your decision making process. That's one of the most costly errors you can make.

As I noted earlier this summer, trying to time the markets is an exceptionally bad idea – 85% of all buy/sell decisions are incorrect, according to Barron's.

Further, the latest Dalbar data shows that the return of an average investor trying to time the market is a pathetic 1.9% per year versus the S&P 500 return of 8.4% over the same time period. Over 20 years, that's the financial equivalent of taking a 342% hit in lost performance.

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About the Author

Keith Fitz-Gerald has been the Chief Investment Strategist for the Money Morning team since 2007. He's a seasoned market analyst with decades of experience, and a highly accurate track record. Keith regularly travels the world in search of investment opportunities others don't yet see or understand. In addition to heading The Money Map Report, Keith runs The Geiger Index, a reliable, emotion-free guide to making big money and avoiding losses, and Strike Force, which aims to get in, target gains, and get out clean. In his weekly Total Wealth, Keith has broken down his 30-plus years of success into three parts: Trends, Risk Assessment, and Tactics – meaning the exact techniques for making money. Sign up is free at totalwealthresearch.com.

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  1. Linda Odubayo Thompson | August 24, 2012

    Hi Keith
    If only more people would read an article like this one. More people would sleep at night. The old saying, slow and steady wins the race is my philosophy in the area of investing.

    I remember my first husband's 401k which if course had all sorts of options in their plans, some very conservative and others very risky in nature. He took the road down the middle and saw an even 5% earnings for over 20 years while others watched their plans jump all over the place.

    Okay he retired and dumped the whole portfolio into an IRA which is another thing that I recommend those with 401ks doing upon retirement because of the restrictions put in place on those plans at retirement. My investor calls when he sees that a bond we bought has realized a nice gain and we sell it and move to another bond. We mainly invest in bonds with only a few preferred stocks. Again slow and steady movement forward without much risk. The only mistake we made several years ago was to buy General Motors bonds and you know what happened to that investment.

    People get greedy and they see their investment keep growing and think well I will stick around just a little more and see what happens instead of taking their profit and moving on.

    Look at the Apple stock for instance, if it is in an IRA well that is good because there is no worry about capital gain when selling it eventually. On the other hand what do you do with that stock as an investor in an non IrA account. You are stuck with this severely over inflated stock which you can't sell because of the enormous capital gains associated with the sale.

    So finally I say that it makes a big difference in what type of portfolio is associated with the kind of investment which would be best suited to that portfolio. For the average middle class American temper the greed and get a good restful sleep.

  2. Paul G Huber, CPA | August 24, 2012

    Keith Fitz-Gerald

    Don't get me wrong, I like you guys, but we don't always agree. I'm looking at your "Five Ways".

    I'm a buy quality and hold kinda guy!

    My wife's jokes aside, most everything I do is on the computer except gardening & Lionel trains. Knowing that a watched pot never boils, I look over my portfolio usually several times a day. I use stop losses, but only infrequently, and I would never set them as low as you suggest. I view stop losses as a decision to sell a stock. They should only be used on long vacations when your antsy or waffling on a sale.

    I prefer long term capial gains, so, as long my confidence in any company remains high, I can tollerate an unrecognized loss while I wait for the fundamentals to become apparent to the unwashed masses.

    Options are nice and but the odds of failure seem higher than the odds of success. I'll stay with selling covered calls. It's really the only sure thing in the option world and even then there is an element of risk. If you miss an opportuniy for a really big gain because of a covered call you sold, you can grow to hate covered calls real quick.

    I'm torn! I'm 65 and started stocks when I was 14 and got coin collecting merit badge when I was 11. Life is good and I have nothing other than Obozo to complain about, I do believe at this point in time I've done better with coins than with stocks. I'm not adding it all up, but unless we get rid of Obozo this fall, Gold (and Silver) and Guns are the best investment I can see.

  3. Richard Giles | August 24, 2012

    Excellent advice, thank you very much. Now I need to print it and paste it on my computer screen so that I do not forget what you have advised.

  4. john gately | August 24, 2012

    When to sell?

    Do you hold the Dividend Masters or sell?

  5. MEGANTELL@GMAIL.COM | August 25, 2012

    I wanted to sign up for Private Briefing at $5 a month, so I patiently clicked on the orange button and filled out my application only to find (at the end) you don't take debit cards – what a dissy!
    We tore up our credit years ago – best thing we ever did!
    What's your problem?

    Terry McKenna

  6. BALU@SCORPIOFS.COM | September 18, 2012

    Hi Keith
    I am from United Kingdom and have recently joined the Money Morning group – in fact only last week.
    My interest lies in Stock Option Trading. Reading 'in-between-the-lines' of your article the message that you are giving is 'Get in quick – keep a watch – once you have hit your target – get out with some profit'.
    Therefore I have the following questions – please excuse me if I sound 'inexperience' because that is what I am – very green!!!:
    1. Do you provide recommendations for Stock Option Trading? If so how do I go about getting it?
    2. If the answer is YES, is there any additional monthly subscription?
    3. If the answer is NO, the 'Hot Stocks' that Money Market recommends, are they Optionable?
    4. I have been trying to look for more information on the 'Hot Stocks' i.e. full back-ground story for each stock but unfortunately no success here. Could you kindly help me?
    5. How often 'Hot Stocks' appear on Money Morning newsletter/site? Is it daily, weekly or whatever?
    I will very much appreciate to hear from you.
    Kind regards
    Balu

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