Successful Trading - Taking Profits - Part 2
Suppose your position has made a big move and you moved your stop to your purchase price as recommended. Then let's say your stock continues to make a big move and now we're asking again the questions we asked back in the first paragraph. The first profit taking technique you can use is a trailing stop. If you moved your stop to your purchase price, then you've already used a trailing stop. Now you can continue to move your stop up as the price rises until the market "stops" you out of the position. So in essence, what you're doing is letting the market decide when to take profits.
Bear in mind that you don't have to use the same price gap that was used when you first set your stop. That initial move was done to protect your account - once you've taken the threat of a losing trade away from your account, you can do most anything with your stop after that. One approach that some traders use is to place their stop at the half way point between their purchase price and the present price. This approach is giving half of your profits back to the markets, but it'll keep you in the market longer giving the stock plenty of room to move. A variation of this approach is to move up your stop to the 75% profit level after a period of time has elapsed.
Another profit taking technique for traders is to use a reward/risk ratio. This is a sound approach that is used more often in short term trading. The way it works is that you determine what amount you are going to risk on a given trade and then set a profit objective expressed a multiple of that risk amount. For instance, suppose you've bought 100 shares of IBM at $50 per share and you've determined that your stop will be placed at $47.50. This position has a total risk level of $250 to your account. If you've set your reward/risk ratio at 4:1, then this means that when the price reaches $60 and your profit is $1000 (4 x $250), you will take profits. Note that using this approach with a 4:1 ratio would only require you to hit one trade in five to break even - a 20% winning percentage.
One last profit taking approach you may want to consider is taking partial profits on that first strong move. In other words, when you get that first move in your favor and you move your stop up to your purchase price, you may want to sell half of your position and take some profits early. You then let the remaining position run using trailing stops until the market stops you out. This approach is used by many swing traders and will result in more winners, but the profits will be smaller. But remember, smaller profits mean that you need more winners.
Chuck Cox is a Technical Writer and Industrial Scientist by professional with a background in statistics. He has used mathematical and statistical methods to invest and trade in the stock, futures, and options markets. Chuck has owned various businesses and presently operates several websites. To learn more about trading the markets, visit his website, http://www.earncashathometoday.com/trading-stocks.htm.
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