Wednesday, 26 September, 2007

Exit Strategy for reasonably Assured Profits

Suggested Exit Strategy for reasonably Assured Profits

Exiting a stock, which is otherwise known as selling your open position is one of the most difficult activities in Stock Trading. And this is not just for you, as a common trader/investor, it is even for me (at times :>>). So, how do you make sure to lock in profits after all.

Eixt Strategy and lock in assured profits

Stocks always trade in Waves, also popularly known as Wave Theory. Which means the stock will continue to go up by say 15% and come down about 10% and go on this way until it hits the top, which again nobody can really predict with precision.
If stocks move up in waves, then why should you just exit at the very first downturn? Meaning, if the stock moved up 15% and then it started moving down and it is down 5%, should you sell. Most people would think, Oh My! if at all i sold the stock at 15% i would have made more and look what happened now, i am down over 5% from the top. And if the stock continues to go down, the fear factor increases. Oh, What if the stock actually goes to the place where i bought it. All of this confusion and fear eventually forces you to Get out of the stock at the Most inappropriate time, usually the bottom. Ever wondered why a stock starts climbing up after you sold and vice versa?

So, how to NOT get into such fearful situations and how to actually make sure you get the maximum profits out of your trades. Let us take an example. I picked up Century Textiles Chart for our demonstration, though this theory can be applied to almost all stocks.

Chart Analysis

* The stock had a major breakdown early this year. The trendline (moving down) was eventually broken on 12th March 07. But if you are an experienced trader, you would wait to see if the trendline is held by the stock and would have eventually bought(say 300 shares) the stock on 16th or 19th march at or around Rs.500. Why only at this price. Because whole numbers play a major role in a stock movement.
* Take the last noted low before this Wave. Let us take 8th march low at Rs.435. This will serve as your Stop loss. Unless of course you are following a different strategy mentioned in my other article. This stop loss will be a trailing stop loss.
* Say, i target 20% profit for my first leg. Which means i will have a Sell order at Rs.600. 24th April stock hits 600. You sell 1/3 of your position, 100 shares pocketing a neat Rs. 10,000 profit.
* Now you change your strategy. Place a Trailing stop loss using the initial difference (500-435 = 65). Your new trailing stop loss would be (600-65) at Rs.535. Next profit expectation is again say 20% which would be at Rs.720 (20% of 600). So, now you have target of 720 with a trailing stop loss at Rs. 535 with 200 shares on hand.
* On 4th July 07 the stock hit 720 target and you sold another 1/3 of the original shares, 100 shares. Now you have pocketed 720-500 = 220*100 = 22000. At this time you have 100 shares left. Now your SL will move to 720-65=Rs.655. Let us say, you again have a 20% profit expectation. Now the equation would be, you have 100 shares at a cost basis of Rs.500, expecting to hit Rs.864 with a trailing stop loss of Rs.655.
* The stock comes down quite a few times but fortunately never hits our stop loss and hence we continue to ride along. We would still be holding the 100 Shares with a paper profit of Rs.816-500=316*100 = Rs.31,600.

Total Profit = Rs.63600 on an investment of Rs.1,50,000 within 7 months. A whopping 43% profit on a stock that moved up about 64% with all the whipsaws removed from the puzzle. If you were to day-trade or even swing trade with any other method, you would have definitely caught on the wrong foot, not once, but many times. And it would be highly unlikely that you traded the same stock many times without any loss on your trade.

The above methodology is NOT fool-proof and may not work always, but it sure is a great way to trade and exit a stock gradually.