Wednesday, March 30, 2011

The Price Went Up! .. Crap, Now What do I do...

Hey there

Before I get into it, it has been almost 2 weeks since I started the site and 5 days since I started advertising and spamming people and the site has received 560 views already. Thank you all so much for coming back, dropping comments and emails. If this is your first time, I hope you find my posts helpful and will keep coming back.

So, many a times when the share price of a company in which I invested in goes up, I ask myself, now what do I do? If there is one thing harder than deciding what company to buy, I think it is deciding when to sell. It is hard to decide when to sell if your position is in the green but it is even harder to sell if you are in the red.

Let us set aside all other factors that may affect your decision e.g. news, market conditions, charts, broker recommendations, whatever your friends say, etc. and focus only on the price.

So say, company ABC, you mange to buy it at $1.00 in a few months it goes up to $1.25, amazing! It is a 25% capital gain in a few months. Now should I hold? What if the price starts to drop and I lose all my gains? (Trust me that happen a lot). And if I sell to cash in my gains, what if it keeps going up? Should I increase my exposure because I think I’m in the right position and hence, amplifying my gains?

Another example, XYZ was bought at $1.00 after a few months; it goes down to $0.75. Now what do you do? You’ve already made a 25% loss. Should you sell to cut your losses? Or wait until it rebounds to sell it at a profit? What if it never comes back up and keeps going down? Or should you buy more shares to average down you costs?

These can be very hard decisions to make, you do not want to take too much of a loss but at the same time you do not want to miss an opportunity to make a profit. On the flip side, you want to make a profit but you do not want to cut your gains short. Putting those sentences together, you get what I think is one of the most basic rules of investing:
Cut your losers early and let your winners run.

Some people prefer averaging down instead of cutting their losses. How is this done?
For example, you buy 1000 shares in XYZ for 1 dollar each. After a few months, the price drops to 50 cents, so instead of selling at a loss of 50 cents a share, you decide to buy another 1000 shares at 50 cents. As a result, your net costs for all 2000 shares are 75 cents each. That way, you would have made a profit once the share price goes above 75 cents as opposed to 1 dollar. This is a very good technique just as long as you don’t run out of capital. If you have all the money in the world, by all means average down all you want. But what happens once you run out of money to buy shares at a lower price? You’ll hope that the price of the shares will go above your cost, but if it does not, you’ll be in big trouble. What if the company goes bankrupt?

I personally prefer to have a trailing stop loss.
A stop loss is when you put in an instruction so that your broker sells a certain amount of shares (volume) from a certain company at a certain price (trigger).
A trailing stop loss is when you move your stop loss trigger up as the price of the share goes up. So once the price starts dropping, you’ll sell the shares automatically.

Look at the below chart as an example.

Above is a chart of Navitas, NVT once again taken from bull charts.
This is a very good example of how a trailing stop loss works. So once, you’ve identified a company and when to buy, you set a stop loss below the highest price at a percentage that you’re comfortable with. In this case, they are the numbers written under the red boxes. As the highest price moves up, so does that number. And when it finally reached a top of $5.56 and dropped back to $4.90 which is the final stop loss, you would have sold it all and made a gain from about $2.50 to $4.90 and avoided the price drop which followed.

So what is your exit strategy? Do you have one? What are your thoughts like when a share price drops and what are they when it goes up? When do you sell and when do you hold? Please leave comments or send me an email. I would love to read what you think or about what your techniques are, we’re all learning after all.

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