When I wrote this headline, I thought: Selling weak stocks and holding strong stocks sounds so natural. But it is not especially for new traders.
If a stock shows weakness and the price is falling, hope sets in. You bought something for a higher price and now it shows a loss. The natural reaction: I did something wrong and now I have to compensate my mistake.
In the stock market you can’t compensate or “repair” your mistakes. If your trading position shows a loss, you have to wait if the price will come back or not. You can’t influence it! But waiting or hope isn’t the right strategy. The odds are getting smaller from day to day that the price comes back to your entry level. Weakness begets more weakness! That’s the nature of trends. A trend is less likely to reverse than its continuation.
The first loss is your best loss! I see the confirmation for this statement if I look at my own trading journal. All losing trades which show higher than necessary losses started as a small loss. If I had sold them earlier, my yearly profit would have been much higher. Of course this is in retrospect, but you can transfer it to the present: Sell losing positions earlier! I rarely have a large winner which showed weakness and a loss directly after the entry.
The key to change your behavior are clear trading rules. You must have proven and consistent rules for selling a weak stock. Here are some examples:
- Close a half position if the stock falls back below the breakout level.
- Sell a half position if the price drops below your entry price.
- Close your position after the prices goes sideways directly after the breakout for more than 10 days.
- Sell a half position if the relative strength is going down or sideways although the price is going up!
- Close your position if important support levels are broken or it closed below the EMA 21 or EMA 65.
These are just examples, but they help you to remove emotions from trading.
I have a clear goal: I want a small average loss over all my trades. The smaller the average loss is, the larger my profit. If you sum up all your losses and divide that by the number of losing trades, you calculated your average loss. That should be much smaller than your average profit.
The opposite to holding losing trading positions is holding your winning positions. The larger the gains, the more you are tempted to take profits. But this is not the right strategy! You must have small losses and really big winners. That means: Letting your profits run!
My rule is: As long as the stock behaves right, does what I expected and no sell rule if fulfilled, I don’t touch it! If the stock reached new all-time highs, pulls back to natural reaction levels and shows high relative strength, I leave it alone. If the stock starts to show weakness, I am watching the price behavior closer. The more weakness a stock shows, the faster I sell it. Here is the link between selling weak and holding strong stocks.
To do this you need a different mindset and that will not appear over night. It takes many years to develop. You have to work on your mindset every day until it changed and became a natural behavior. Set up rules, backtest them to build up confidence and follow them with discipline. That help you to cutting your losses short and letting your profits run.