“You’ve got to know when to hold ’em, know when to fold ’em, know when to walk away, and know when to run.”
– Kenny Rogers, “The Gambler”
“So what brings you to Liberty Through Wealth?”
The answer seems obvious: You wanted profitable investment recommendations.
Yet, as all successful traders know, the stocks you buy are only a small part of profitable trading.
Many investors get into the market following a specific tip. But once they are in a position, they have no idea how they will exit.
As trading coach and market “wizard” Van Tharp points out, investors seem hardwired to ignore exits.
Perhaps it’s because exits remind us how little control we have over market movements. No investor can control when exits are hit.
Yet, as experienced traders will tell you, exits are the only way you can control the market. After all, exits determine whether you make a profit or a loss. And exits control how large that profit or loss will be.
All this leads to a highly counterintuitive insight: Most traders focus on the importance of the entry. However, managing your exits turns out to be far more critical in generating profits than what you buy.
Two Kinds of Exits
Let’s delve a bit into exits, often called stops.
First, there is a protective stop, or stop loss. It’s the initial stop you place on a position to limit your potential losses.
Think of your protective stop as your worst-case scenario.
As Tharp says, “Your protective stop is like a red light. You can go through it, but you’re not very likely to do so safely.”
Second, there is a profit-taking stop. This is when you adjust your initial protective stop upward to lock in a gain.
Say a recommendation has shot up quickly, like the Oxford Wealth Accelerator recommendation Grayscale Bitcoin Trust (OTC: GBTC) I made on May 8.
By adjusting the initial stop loss from 30% below the entry price (the protective stop) to a level that eventually reached 30% above the entry price (the profit-taking stop), subscribers locked in a quick 30% gain from this bet on bitcoin.
How I Calculate Stops
Stops are a vital element of my Oxford Wealth Accelerator exchange-traded fund (ETF) recommendations.
For each recommendation, I carefully calculate volatility-adjusted stops.
Volatility-adjusted stops assume that a certain amount of volatility is just market noise. And a well-placed volatility stop lies just beyond this noise.
Volatility-adjusted stops also mean that stops for volatile positions are wider than those for stable, low-volatility ETFs.
For example, the stop on a volatile asset class like Grayscale Bitcoin Trust is far wider than it is for a stable, defensive utility ETF like Fidelity MSCI Utilities ETF (NYSE: FUTY). A 10% daily swing in the price of Grayscale Bitcoin Trust might be par for the course. The same percentage move in Fidelity Utilities may signal serious problems.
As a position goes in our favor, the protective stop will morph into a profit-taking stop. Say a position is up by 15%. As a rule, I will then recommend that you tighten your profit-taking stop to lock in at least a 10% gain.
There are variations of protective stops. In Oxford Wealth Accelerator, the initial stop loss is also a trailing stop. That just means the stop level adjusts upward as the position goes in your favor.
The Oxford Club’s research department updates both stop loss levels and profit-taking stops daily on the Oxford Wealth Accelerator online portfolio. (The team also sends out a special email alert each time a stop is hit.)
As a practical matter, I recommend you enter your stops in your brokerage account at the same time you make a purchase and adjust them as stop prices are updated. That way, you won’t need to monitor your stops. Your trades will be executed automatically. All major online brokers now allow you to do this.
What’s the takeaway?
Wall Street, the financial media and most investors focus solely on identifying the next hot investment idea. But don’t ignore the importance of exits as a crucial part of limiting your losses and locking in your gains.
P.S. Kenny Roger’s song “The Gambler” embodies well the ethos of a successful trader.