Strategies for Handling Profitable Trades

Profitable trades are somewhat easier to handle than losses, but they’re not without complications. You must decide whether you want to leave your stop-loss point where it is or try to lock in a small profit by moving it up.

You obviously want to try to keep any profit from turning into a loss. For example, say that you enter the GLD trade, and a few days after entering the order it remains in positive territory with a small profit.

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For this discussion, assume that your original stop price is $65.50, the midpoint of the trading range. Your choice is to leave the stop where it is or move it above the resistance line, to $67.50. If you choose the former, and the stock trades below $65.50, your formerly profitable trade will be closed for a loss.

If you choose the latter, you will be stopped out if GLD trades below $65.50. You must now decide whether to move your stop-loss order to protect the small profit, or leave the stop where it is to keep from jeopardizing the stock’s chances of gaining more.

This balancing act is delicate. You’re trying to catch a bigger trend higher, which argues for leaving the stop where it is for a little while longer. But sooner, rather than later, you’ll want to move your stop-loss above your entry price. This decision becomes easier as the position progresses. As your profit grows, you’ll want to continue adjusting your exit points upward. This is called a trailing stop.

Break the pattern of higher highs and higher lows

Trends are easy to see on charts. You can easily identify the trend that carried the price of this GLD ETF from less than $65 per share to $100 per share in six months’ time. In this case, the ETF creates a series of higher highs followed by higher lows, interspersed with several retracements.

[Credit: Chart courtesy of StockCharts.com]
Credit: Chart courtesy of StockCharts.com

Although this pattern sometimes is difficult to define rigorously, you can easily identify it on a chart. Take note that the ETF’s price appears to ride the moving average line as it progresses. As a trader, this kind of trend is the type you want — and like — to ride for as long as you can because it’ll make you some money.

There are also a couple of clues that this trend came to an end in March 2008. Notice the price gaps that occur in March and the accompanying high trading volume. These gaps are your first hint that the ETF may be in trouble.

Another hint is shown at the point where the line indicating the ETF’s price closes significantly below its moving average. A third hint is when the stock fails to reach a higher price after the gap occurs.

Any one of these events may carry enough weight for you to close your position. Taken together, they clearly signal that the upward trend probably is over, and you need to exit your position.

How to use trailing stops

After you’ve entered a position and it becomes profitable, you want to move your stop to protect your profits. This is known as a trailing stop because you keep moving it higher as your profits grow. In an uptrend, a stock makes intermittent higher highs and intermittent higher lows. Use the higher lows to define your stop points.

After the ETF has made a higher high, reset the stop to either the most recent higher low, or the one just before it. After the ETF reaches a new high in early October, you should reset the stop using the most recent interim closing low around $72.00.

How to track market indexes

Individual stocks and entire sectors of similar stocks regularly fall in and out of fashion. Sometimes these changes happen in a grand way, such as when the financial sector fell out of favor in 2007 and 2008.

Look at the weekly chart of the S&P 500 Index. Although the S&P 500 index peaked in October 2007, by 2008 it had formed a lower high and lower low below its recent intermittent lows. The price also closed well below its 52-week moving average.

By the time 2008 rolled around, the vast majority of financial stocks were in worse shape than the broad market index — a prime example of a dramatic shift in market conditions. If you were trading at the time, you could

  • Sell your positions when you saw that prices, market fundamentals, and technical indicators were simultaneously deteriorating.

  • Wait out the market, hoping things would get better.

    [Credit: Chart courtesy of StockCharts.com]
    Credit: Chart courtesy of StockCharts.com

If you held financial stocks during that time and chose the second option, you took a much greater loss by selling later. Unfortunately, many buy-and-hold investors unwisely believed that the downturn was a temporary blip and that financial investments would remain viable. In fact, a number of companies never recovered, and some no longer are trading.

The right choice then, as usual, was to close your positions. By following these simple strategies, you’d have had more than enough information to know that things were not going according to plan. Although you wouldn’t have sold your stocks at the highest prices, neither would you have ridden them to their ultimate lows. By selling, you protect your profits and your trading capital so you can trade another day.

Knowing when a trend is complete is just as difficult as knowing when it began. You can’t trade with perfect knowledge, and you can’t predict the future — neither can we. But you can use these tools to identify when a trend is likely to begin and when it’s likely to end. And if you use excellent money management, you’re likely to trade profitably.

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