Keep More (And Lose Less) With This Simple Trading Rule
Investing or trading can be emotional enough. But what really tears at most people is watching a big winner sink. We all want to sell the stock at the very top. When we don’t and begin watching the total return column sink, we tell ourselves something like, “I should have sold two days ago at the peak.”
But investing in the market hardly ever goes how we imagine.
Fortunately for us over at Maximum Profit, we have sell signals in place. Of course, we aren’t going to nail the exact top, but we also won’t ride it all the way down.
A successful investor is rarely the first to the party. Neither is he the first one to leave. After all, we don’t exactly have a crystal ball. Our goal is to catch the bulk of the gains while keeping our losses small.
But how do we expect to do that in today’s rocky market? After all, we have seen wild swings in stock prices. Shares can be up double digits one day and down double digits the next. Gains can evaporate just as quickly as they came.
Chances are, you know exactly what I’m talking about… one day you’re sitting on some nice gains. But as the market (or stock) quickly plummets your gains vanish. With any luck, you get out relatively unscathed. But the psychological toll it takes makes you second guess everything.
It is one of the most frustrating things about trading. Thankfully, I think I have a solution…
Take Gains Off The Table – And Keep Profits
I’m constantly trying to figure out ways in which my readers and I can book profits quicker or nail the exact top — or as close to it as possible. Unfortunately, there’s just no magic potion, indicator, or holy grail that tells us when the top is in and it’s time to book our profits.
But I’ve found something that’s pretty close.
You see, I’ve been doing a little backtesting… And I’ve found a way to squeeze a little more profit out of many of your trades. This is especially important in today’s volatile market environment.
I’m talking about the rule of thirds.
Now, before I go any further, it should be said that there are some downsides to this approach. There is no perfect solution. We’ll cover that in a bit. But first, let’s talk about how it works…
The rule of thirds consists of pulling 1/3 of our trade off the table as our shares rise. Let me give you an example of how it works with a recent trade.
Last September, the Maximum Profit system flagged Paylocity (Nasdaq: PCTY) as a buy. We added the stock to our portfolio on September 20 at $98.83 per share. We hit our trailing stop loss on March 9, so we closed out of the trade the next day at about $116 per share.
Our gain was just over 17% on the trade, which means you would have made over $1,700 on a $10,000 investment. It isn’t anything to write home about, but it still crushed the broader market’s 3.7% loss during that period.
However, had we used my new profit-taking rule of thirds, we would have squeezed another 13 percentage points out of the trade.
Here’s how it works…
How The ‘Rule of Thirds’ Works…
For every trade we enter, we set profit target prices. Once we hit that target, we take 1/3 of our trade off the table. We will have our first third, our second third, and then what I call our “Runner.”
Our first third is set at 25% above our entry price. Our second third is set at 50% above our entry price. Finally, with our Runner, we will simply ride out until one of our sell signals are triggered.
Now, let’s go back to that Paylocity trade and see how we would have done using the new profit target prices (there will be a bit of math here so bear with me).
For this hypothetical, we will use a $10,000 investment. This means we divide $10,000 by our entry price of $98.83 per share, which gives us 101.2. Since we can’t buy fractional shares, we round down to 101. We split our 101 shares into thirds. 101 divided by 3 gives us 33.7, so we round up to 34 for our first two profit targets, and that leaves us with 33 shares for our Runner.
In short, we will sell 34 shares if we hit our first profit target price, 34 shares if we hit our second price target, and 33 shares on our Runner.
With Paylocity, our first profit target price was $123.54 per share (25% more than 98.83, which was reached on January 2nd.) That triggers our first sell, which pulls 34 shares at $123.54, or $4,200, off the table.
Our next profit target price was $148.25. Shares of Paylocity hit that figure on February 4. So, we would have sold 34 more shares (our second third) at that price, which gives us about $5,040 ($148.24 x 34 shares) that we pulled off the table.
Now, we are left with our Runner. We let this go until one of the Maximum Profit system’s sell signals are triggered. (One of our signals is a 20% trailing stop. If you’re not a premium subscriber, you can set your own targets in a similar manner.)
We stopped out of Paylocity when shares closed below our 20% trailing stop loss on March 9. We sell our remaining 33 shares the next trading day for around $116 per share — $116.03 multiplied by 33 gives us about $3,829.
Now if you add up all of the profits ($4,200; $5,040; $3,829) we get $13,069. This means on our initial $9,981.83 investment we would have made over 30% on the Paylocity trade, compared to our original return of just over 17%.
That’s an extra $1,350 in your pocket by simply following this profit-taking rule.
Action To Take
This isn’t just a one-time special situation, either. I went back and tested this strategy on numerous previous trades as well. I tested a few other examples on trades we’ve made recently… If we used this rule, then we would have made a difference of 10%, 10.2%, and 13.2%, respectively. These somewhat small differences might not seem like much, but they add up to thousands of dollars back into your pocket compared to the original return.
It just goes to show that you need to be constantly reevaluating your trading strategy. We should always be learning, always getting better. I encourage each of you to take a look at this and see how it would have impacted your recent trades and feel free to implement this on your own, too.
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