The old Warren Buffett quote goes, "[Y]ou only find out who is swimming naked when the tide goes out.” What few realize is that Buffett may be talking about you. That’s because in the stock market world many amateur investors and even professional traders don't realize that they are completely exposed when the market turns against them and the tide eventually goes out.
It’s simple. Many people focus on only one side of a trade: the buy. And they completely ignore the other side of the trade: the sell. You have to get both sides correct to make money in the markets, yet so many focus only on the buy side. You can't flip on the television without seeing some talking head telling you to buy this or buy that, but where's the advice on when to sell that hot stock, sell the mutual fund of the week or dump that precious commodity?
I intend to help you fill that cavernous void of advice and lay out a three-step strategy aimed at helping you find your "uncle point." It's the threshold of pain that once crossed convinces investors to throw in the towel and sell.
To identify yours, let me share a basic three-step plan designed to help you complete the most critical component of every trade: cutting your losses short and letting your profits run.
Find and buy momentum. Buying a stock or investment because it “feels” like a good deal or it’s at an all-time low is a recipe for disaster. Markets tend to move in trends and if you’re prepared the trend can certainly be your friend.
The easiest way to identify a trend is to use a technical approach to identify positive price momentum in a specific stock, exchanged-traded fund or commodity. Your goal is to search for a price that appears to be trending quickly higher on a historical basis. A good example of this would be using metrics for identifying variation in a stock’s performance compared to historical trends, such as moving average conversion and divergence.
Set a hard stop. The most basic approach to setting your "uncle point" is to determine a hard stop when you place your buy order. This again should be based on the historical price action found by using a moving average.
For example, let’s say you buy a share of stock in a company for $14 and you determine it's likely to trend higher to $20 (your profit target) you should immediately place a stop limit order for the price you're willing to let it fall to, say $13.60. That’s your “uncle point”.
Do daily housekeeping. You need to constantly reevaluate your "uncle points" and profit targets for every position you own because market prices change daily and so will your key to buying and selling: the moving average.
If you're not up to this kind of responsibility and work you're not investing, you're gambling and probably better off hiring a professional money manager who systematically follows a set of buy and sell rules that can be both measured and back-tested.
Rob Russell is the best-selling author of Retirement Held Hostage, CEO & CIO of the Ohio-based Russell & Company, a private wealth management firm specializing in helping affluent individuals ages 45 and up create and preserve their wealth. He co-hosts a radio show, authors The Rob Report blog, and has been interviewed by CNBC, FOX Business, The Wall Street Journal, and several other national and international media outlets.