How do I keep from selling too early?
A great question and one of the hardest. It goes hand in hand with how do you keep from selling too late. When a stock is moving up in new high territory, it has no overhead, so we tend to let it run. It will not run forever, however. It will have to come back and regroup before moving back up. Stocks all vary in how far they pull back before moving up. Some give back 25% of a gain, some 50%, some more, some less. During the recent rally, we have seen the 10 and 18 day moving averages act as support for strong stocks. That is easy-when the market is going up, we can ride out the small pullbacks on lower volume. That is what you want to see, and that is an opportunity to add to positions (we often do this as a stock performs as expected-we have a winner, and we like to focus our funds on winners).
The issue gets clouded when we have a hiccup similar to the one in early January. Many of the leaders broke below their 10 and 18 day moving averages, breaking the pattern that they had followed since rising out of the October lows. That threw a lot of investors, and many sold. That is fine if you are in a shorter term play with options or even stock if your intentions are short term. Indeed, in those cases, you most likely should be drawing trendlines and selling if the stock violates the trend and cannot move right back up into the trend. Trendlines are tighter than moving averages, and get you in and out of plays faster. If short term profit maximization is your goal, trendlines are what you need to trade off of.
If you are longer term trading, anywhere from four months to years, trendlines are most likely not for you. If you are holding a CSCO for the long term, you don't want to worry about 10 and 18 day moving averages either. Strong stocks will sell back when the market corrects. But they usually find support at their 50 day moving averages if all is well with the stock and the market is not proceeding into a long bear period. Using these as trading lines is much more conducive to holding onto positions long term. As with trendlines, if it is breached, we don't sell immediately, but we let the stock try to recover. If it cannot move back over, we need to consider selling before major losses mount if the market is correcting further.
How you trade, what averages you use as support, and what stop loss levels you set depend upon your investment tolerance and your goals. In early January, we were stopped out of several positions in our options because we did not want to chance a longer term correction even though we felt the selling would be short term. It behooves us, however, to be ready to get back in when the stock turn and show us they are going back up if we see the play developing. With longer term positions, we did not do anything-they did not breach their 50 day moving averages even though they did break their trend of riding up the 10 and 18 day moving averages.
As with any strategy, you have to know what you want to do before the event happens. It is very hard to make sound decisions under fire. If you are in for the short term and your trendline is breached or a stock cannot break resistance, you need to know if you are going to exit or hang on. Know your positions and know what you want out of a position. We try to let our winners run as long as they are 'acting right', moving up on solid volume, pulling back on lower volume to the expected support lines.
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