Stop Driving Your Car Without Brakes

BY KEITH KAPLAN CEO, TRADESMITH

Imagine you get in your car and head to the supermarket. But after you get on the road and pick up speed, you go into a panic…

… because you just noticed there’s no brake pedal. You have no ability to stop or slow the vehicle.

Then, your steering wheel locks up and you panic even more. You have no ability to steer the car.

Now, you’re in a car with no brakes and no functional steering wheel. You’re in motion and in danger. Not good.

You’d never choose this, right? That’d be crazy.

But believe it or not, this is how most people manage their investment portfolios. They get into investments with a destination in mind… but no plan for what to do if things don’t go as expected.

Then, when things don’t go their way, they panic… and let emotions guide their decision making.

Instead of simply letting off the gas and slowing to a stop, they’re taking their chances with the ol’ tuck-and-roll maneuver.

You see, the decision to enter an investment or trade is just step one. One that comes after is just as, if not more important.

That’s position management, or what you do with an investment or trade after you’ve gotten into it.

We’re going to talk about position management today – and the solution TradeSmith provides you to make it dead simple.

What’s Your Plan?

Let’s say you buy a stock that you believe has the potential to triple in value, but instead it sinks 50% in value.

Or let’s say you buy a stock that surges 50% in short order and then retraces all the way back to where you bought it.

Do you know what to do in either scenario?

If you don’t, then you don’t have an exit strategy… and that needs to change.

Skilled investors always have an exit strategy. Unskilled, undisciplined investors rarely do.

But it’s an easy fix.

For a lot of great investors, a key part of any exit strategy is a powerful financial tool called a stop loss.

A stop loss is a predetermined price at which you will exit a position if it moves against you. It’s when you say, “Well, I’m wrong about this one. Time to cut my losses and move on.”

For example, let’s go back to that first scenario. If you buy a stock at $10 per share, you could consider using a 20% stop loss.

If the stock goes against you, you would exit the position at $8 per share – 20% lower than your purchase price. That answers the first scenario: you would be out of that position well before it became a 50% loss.

But now, think about the second scenario – where a 50% gain turns back into breakeven. A stop loss doesn’t help there, does it?

That’s where an even better exit strategy is in order…

The Ideal Exit Strategy: Trailing Stops

Trailing stops are a simple, but powerful adjustment on the idea of stop losses.

When you use a trailing stop, the price where you decide to sell rises along with the stock price. So, as your position profits, you gradually lock in more and more of the win.

Let’s return to that earlier example of riding a position 50% higher, only to watch it sink back to breakeven.

Instead of using a fixed stop loss, you could instead use a 20% trailing stop loss. With this strategy, the stop loss follows your position upward.

If you buy a stock at $10 per share, and it rises to $15 per share, your stop loss goes from $8 to $12 per share. If the stock turns against you and falls all the way back to $10, you lock in a profit of $2 per share no matter what.

And the beauty of a trailing stop is that it never goes lower. If the stock never rises, it acts just like a normal stop loss.

With this in mind, there’s almost no reason not to use trailing stop losses as part of your exit strategy.

And at TradeSmith, we made it our mission to make setting trailing stop losses dead simple with our TradeStops software.

With TradeStops, you can sync your brokerage account with our platform and automatically get our recommended trailing stop-loss levels for every one of your positions, based on where you bought it AND the stock’s unique risk profile.

This is what we call the Volatility Quotient (VQ) trailing stop. Using our advanced algorithms on a stock’s historical data, we recommend different stop-loss levels based on how a stock behaves.

For “steady eddy” stocks, we recommend a narrow stop to lock in profits. For more volatile stocks, we recommend a wider trailing stop.

Our research has shown that holding wider stops on stocks like these helps keep you “in the game” for longer… letting great growth stocks do their work even if they chop around a bit on the way to bigger gains.

That’s why a company like Walmart (WMT) has a VQ of 13.87%… and a stock like Robinhood (HOOD) has a VQ of nearly 47%. They’re different beasts. And so, we shouldn’t treat – or trade – them the same.

That’s just one example… and I’m sure it brings to mind some of your own past trades you’ve had to manage through volatility. I’d love to hear about your experiences – good or bad – so let me know at feedback@tradesmithdaily.com. Be sure to note if your story takes place with or without using TradeStops; I’m hoping it’s been a game-changer for many of you.

How TradeSmith Makes Your Exit Strategy Simple

All the work we do at TradeSmith comes back to this simple, foundational idea: Have an exit plan – and stick to it.

At TradeSmith, we’ve spent more than $18 million and over 11,000 man-hours developing software tools that make it easier than ever to master and utilize the foundational components of smart investing and trading.

That’s because your success is important to us.

And I don’t mind sharing that there’s some self-interest here on my part. I won’t deny that.

The way I see it, the more of your investment or trading gains you retain and the more losses you keep small, the more money you’ll make and the better your experience in the markets will be… and the more likely you’ll be a long-time customer of ours.

We hope to play a role in helping you achieve your financial dreams as quickly and as safely as possible.

We’ll be there every step of the way.

Enjoy your day – and be sure to share your “war stories” about stop losses, etc., at feedback@tradesmithdaily.com.

All the best,

Keith Kaplan
CEO, TradeSmith