Avoid Costly Mistakes With This Proven Sell System
Emotion is the bane of traders. It causes us to act rashly instead of rationally, and typically at times when it’s most costly.
It has been shown that investors are most bullish at or near tops and most bearish at or near capitulation bottoms. Just look at the mania right before the dot-com bubble burst or the despair during early 2009 following the credit crisis meltdown. In both instances, the trend was turning as emotions peaked.
There’s only one way I know of to remove emotions from investing: following a rules-based system built on a measurable, repeatable process.
And the system I follow in my premium newsletter, Alpha Trader, has worked very well for me and my readers.
We’ve detailed numerous times how our proprietary indicator, the Alpha Score, goes about selecting stocks poised to make huge runs based on a relative strength (RS) score above 70 and a fundamental trigger. (For more on how the Alpha Score works, you can read this article.)
But today, I want to talk about how our rules-based system helps ensure success once we are in a position. At that point, there are two critical components:
1. Letting our winners ride; and
2. Knowing when to sell.
Let’s look at how our system accomplished these goals without letting emotions get the better of us using Micron Technology (NASDAQ: MU) as an example.
In October 2013, the Alpha Score signaled MU was a buy. One month later, shares were up 17%. Within four months, they were up more than 50%.
For most investors, a gain of this size in just a few short months would trigger an urge to sell. Because they have been conditioned to buy low and sell high, they grow increasingly nervous as a stock hits new high after new high. Eventually, the fear gets the better of them and they sell.
And I’m guessing more than a few of my readers’ guts were telling them to sell MU for a 50% profit. But the Alpha Trader system had not signaled it was time to exit — and those who trusted in the system were well rewarded. When all was said and done, we closed the position for an 88.5% gain in just under 15 months.
Micron Technology is far from our biggest winner. The Alpha Score has led us to stocks that soared 115% in six months, 135% in 10 months and 242% in a year. But MU is a great example of how we use our rules-based system to let a winner ride.
To be sure, the ride was not straight up, which brings me to the next critical component of investing: knowing when to sell.
In Alpha Trader, we have two quantitative sell rules that take the emotion out of the process.
First, we employ a stop-loss on every position. The stop is set 25% below a stock’s six-month high. If it hits that level on a closing basis, we sell — no questions asked.
That may seem like a wide stop, but it gives us plenty of breathing room to avoid getting shaken out of a position during a normal correction within a larger uptrend.
I don’t expect this stop to be triggered often, but it will be an invaluable failsafe when the next bear market hits, since stocks can trend down and still relatively outperform.
The more commonly triggered sell signal occurs when momentum wanes and a stock’s relative strength falls below 70.
As you can see in the chart below, during the time we held MU, the stock went through three corrections with shares down between 15% and 22%. I’m sure many readers were more than a little scared, wondering if their gains were going to evaporate before their eyes.
This emotional response is what leads many traders to sell a winner too early — perhaps right before the stock makes another run big higher, which is exactly what happened with MU. But since the Alpha Trader system did not give a sell signal on any of these corrections, we held tight.
In January 2015, MU finally stalled out, and a sell signal was triggered as the stock’s RS fell below 70. This change in momentum is generally a precursor to a larger downtrend. In the case of MU, shares were down 14% in a little more than two months. And they are now down over 50%.
I think it’s pretty easy to understand how we could have been rattled on MU’s volatile ride if we weren’t following our rules. But the Alpha Trader system took the emotion out of it, allowing us to book a big profit.
In short, I trust in our system. It helps me sleep well at night rather than losing precious hours worrying about when to buy and sell. And it’s important that every investor has a system they can trust in, especially since we already have a five-year bull run under our belts.
I’m confident the Alpha Trader system will allow us to continue riding out the rest of this bull market and help us get out when the trend finally changes. If you’re interested in learning more about how it could help you do the same, we’ve put together a short presentation you can view now.