Saturday, February 11, 2006


Sell into strength or sell into weakness?

Despite a lousy Friday in which my portfolio lost ground to the broader market, I finished the week up $6,826 (1.0 percent), which still compares favorably with the S&P 500 (up 0.2 percent), the Nasdaq (down 0.1 percent), and the Russell 2000 (down 1 percent).

So suppose you've done your homework and bought a stock and then all of a sudden, the stock starts moving up. Do you sell when you think the stock is no longer worth owning based on "fundamentals" or do you let "your winners run" in the hopes of boosting your profits?

That's a really tough question, and I don't have a good answer. In the past, I would just set sell limit orders at increasingly higher levels and would wait to see if the order got filled. I didn't give much thought to how the stock reached that price point (was it on high volume, or low volume, etc.). Now, I'm trying to refine my technique by "letting the market tell me when to sell". For example, if the stock moves up on high volume, I tend to be more patient.

One way to "let the market tell you when to sell" is to use trailing stop orders, something that both Ameritrade and Scottrade (the brokers I use) allow me to do. This is a handy tool, especially for people like me who have full time jobs and can't look at their portfolios more than once or twice per day. However, the problem with trailing stops is that if you're trading microcaps, the volatility is so great that it's easy to get stopped out, even if you set the stop to give you lots of breathing space. Personally, I don't use stops. I just prefer to use my proprietary trading system: my gut.

Great question, and one that I think about every day. The one great benefit of placing sell limit orders for microcaps is that it turns their inherent volatility and whipsaws into an advantage. This is especially true with scale-out partial sell orders.

Does that advantage outweigh the disadvantage of being taken out of a position that may turn into a runaway train? In most cases I think so, because I have seen so many microcaps spike and then fully retreat.

However, a single runaway train can make up for a lot of opportunities to take small profits. So I guess you would have to know: (1) how frequently your stocks turn into runaway trains; and (2) how much more you could make from holding onto the runaway trains than, say, scaling out at 25%/125% or whatever profit targets you typically use.

I'd love to hear your thoughts as you explore this issue further.
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