Today we’ll highlight a few pointers on how to handle a “good” problem: What to do with winning stocks that, soon after your buy, have zoomed 20% or more.
Paradoxically, it’s these types of situations that cause the most stress and uncertainty. Profits are good to have, but if a stock goes vertical, you’re left wondering how to properly manage your good fortune. The prospect of making a decision, either sitting tight or selling, can cause investors to behave irrationally.
The solution, as usual, is to have a plan and follow it consistently over time. There are only three things you can do when you get a quick, big winner: hold it all, sell it all, or sell some and hold the rest. As I’ve written before, we prefer one of these methods to the others (the latter), but I’ll review the plusses and minuses of each below.
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If you decide to hold all your winning stocks, you should aim for a bigger gain over time … but also be prepared for painful corrections along the way. If your stock runs from 50 to 70 in just a couple of weeks, and you decide to hold your position, that’s fine … but don’t kick yourself if the stock then has a normal pullback to 58 or 60.
If you decide to sell all your shares up at 70, that’s fine too; there’s nothing wrong with booking some profits, especially when you get a windfall gain in a short period of time. However, you shouldn’t get upset if the stock pulls back a few points only to rocket to 80 or 90 in the weeks or months to come.
I actually prefer the third option, which is selling some shares (somewhere between one-third and one-half of your position), but holding the rest. This approach not only allows you to book some profit, rewarding yourself for being right, but also giving you leeway (because you took some off the table) to ride your remaining shares through the inevitable correction ahead.
The goal with this third option isn’t so much to grab the profit from your winning stocks but to ride out what could be a major, longer-term move by lessening your risk, which decreases your chances of being kicked out on a sharp (but normal) correction.
I’ve actually been tempted lately (if I could only find some free time) to produce a concise educational presentation on the three pillars of investing results. I’m referring to your batting average, your slugging percentage and your turnover.
Your batting average is simply your winning percentage. If you made 10 trades, and six of them resulted in profits, your batting average would be 60% (or .600 for you baseball fans).
Your slugging percentage is your average gain on your winning stocks, divided by your average loss on your losing trades. Using the above example, let’s say your six winning trades brought you a total of $6,000 in profits (or an average of $1,000 per winning trade), while your four losers lost you a total of $2,000 (or an average of $500 per losing trade). Your slugging figure would be 2.0, that is, $1,000 divided by $500.
The last pillar is the easiest to grasp, it’s simply the number of trades you make per month (or year, or whatever time period you choose).
Obviously, the higher any of these three pillars, the higher your returns. The more winning stocks you have, the bigger your winners will be compared to your losers, and (assuming you’re a profitable investor) the higher the frequency of trades, the more money you’ll make.
The tricky part is that these levers often work against each other. Let me explain.
Let’s say you’re more of a swing trader, holding stocks for a few days to three weeks. Well, you better have a pretty good batting average; the key for your success will be consistently churning out gains, and doing so often. It’s unlikely you’ll have a two-to-one or three-to-one slugging percentage, because you’ll likely be booking both winners and losers quickly.
Conversely, if you’re more of an intermediate- to longer-term investor, your bread and butter will be your slugging percentage. You always hope to have a bunch of winning stocks, but the key will be landing a few enormous winners, while cutting losses relatively short.
Finally, the last lever, your turnover rate, is really something that shouldn’t be played with. If you decide to, say, trade twice as much, I can tell you right now that your batting average and slugging percentage will slide because you’ll probably be forcing some bad trades.
The point here isn’t to reveal a “best” combination of the three (there is none!), but instead to start thinking in terms of these three metrics when evaluating your own results. While you don’t need a spreadsheet that’s exact to the decimal point, you should have a list of your results that you can peruse from time to time.
For instance, say you’re in the midst of a trading slump, so one weekend you start digging into your results. If you notice that your batting average is way down, it’s possible that either the market just isn’t as healthy as it appears, or (more likely) that your stock selection has gone to pot. If you’re slugging percentage is way down, it’s likely that you’ve been bailing out of some high-potential stocks too early … or letting your losses get out of hand.
Again, there are no magic answers in the market, if there were, we’d all be rich, but keeping these three pillars in mind is a creative and also more precise way to evaluate your own trading.
How do you like to handle your winning stocks?
*This post has been updated from a previously published version.