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Letting Your Profits Ride

Apr. 29, 2011 5:57 PM ET
TimerFrank profile picture
TimerFrank's Blog
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Stick With The Plan

This may seem like a common sense statement, but the reality of market timing is that the majority of timers "think" they can stick to a timing strategy, however when the market moves against them, as it always does as some point, they are swayed by financial news stories, the desire to be "with" the crowd, and their own emotions, often exiting the strategy at exactly the wrong time.

Think about it. Let's use a fictional market timer named Mark for this example.

Mark has a strategy he knows has, over many years, outperformed the stock market. Mark knows going in there will be times when the strategy will lose. He sees this in the historical trades. He accepts this or at least he thinks he does.

But then, the market turns against Mark's first buy or sell signal and he is down 2%, then 4%. Mark is counting the dollars. He wakes up during the night with feelings of dread. Maybe "this" time it is different.

The next day, Mark exits the strategy and immediately feels better. He starts searching the internet for a better timing service. They are easy to find. We have personally seen some that "guarantee" 800% and 1000% returns. Much better than that 4% loss.

Of course the day after Mark exits the strategy, the market reverses and within a few more days, the strategy is now back in positive territory. Mark cannot enter, because he has lost 4% and knows it is not wise to enter mid-trade.

Mark is now feeling upset again. The initial feelings of relief when he exited the trade are gone. Mark is starting to feel he is missing out all over again.

After watching the market continue to advance, Mark finally makes a decision and re-enters the position after it has a nice 10% gain. Mark is feeling good again as the market has obviously turned and he is back on board.

Immediately the market takes back 4-5% of those gains and Mark now has a loss, that never should have occurred, of 8% to 9%.

Those who stayed with the strategy from the initial buy or sell signal are in positive territory and have a nice gain. Mark, however, exits again, with double his original loss, and quits market timing for good.

None of this need happen. When you start following a strategy, plan to stick with it for several years. That is how the smart money makes profits. They do not let emotions rule their trading decisions. They stick with the plan!

The Trend Is Your Friend - Trade With The Trend

At FibTimer, all of our timing strategies are based on trend trading. We know that the financial markets are usually in a trend, either up or down. So we enter the markets "after" we have identified a trend.

It is great to catch a reversal. It is also very difficult. Let me rephrase that.... it is almost impossible. We read stories of those who have perfectly caught a reversal, but they are news stories "because" it is so uncommon.

It is much easier to wait for a trend to begin, and then jump on board. If the trend fails, and some do, a well managed timing strategy will exit to cash, or reverse position, with only a small loss (or even a small gain). When the trend keeps going, that same well managed timing strategy rides the trend as far as the trend goes. This is where the power of trend trading is seen. By never missing a trend, and staying with the trend, trend following market timers make huge profits over time.

Finally, one of the most dangerous trading methods is to take a contrary position and pray for a reversal. Such trades rarely work out. But many, many traders try them. And... many, many traders lose a lot of money.

Let Your Profits Run - Cut Your Losses Short

The second part of this rule (cut your losses short) is the toughest one.

It involves admitting that you were wrong. But in market timing, as in "all" trading, it is a rare moment indeed where you will eventually be proven right after first being proven wrong.

The FibTimer strategies are designed with strict risk management right from the start. We "never" let losses grow. If we issue a buy or sell signal, and our indicators reverse, we reverse position (or go to cash) immediately. If you look at our various strategy trade histories you will see that we rarely take a loss of more than a few percent.

There is a reason for this. It is easy to make back a small loss. However large losses are not only hard to make up, but the psychological pain you experience from them could cause you to quite the strategy. And quitting with a loss not only guarantees that you will lock in the loss, but it is likely to have a detrimental effect on your buy and sell decisions for a long time.

The opposite of course is "letting your profits run." At FibTimer we never set a profit target. As far as we are concerned, when we have a profitable trend going, the sky is the limit. We will stay with that trend as long as it is profitable. 20%, 50% 100%. We "never" limit profits.

This is why small losses do not concern us. We know that when we have our next profitable trend, we will ride it to the end.

Never Make Timing Decisions Based On Tips

A tip is rarely more than opinion, and frequently a bad one at that.

Even if the tip comes from a friend, don't take it. If you have a hard time with this, go back to "The Trend Is Your Friend."

Burn this into your head! Unfortunately, in market timing, a "friend" is not always a friend.

This is another (of many) reasons why we follow non-discretionary timing strategies at FibTimer. There is "always" a reason to doubt a trade. There is always someone who knows, absolutely, that the trade is wrong. In fact, they are often willing to go into great detail why you are making a bad trade.

Why would they do this? Simple, it is to prove to themselves that their trade is the more correct one.

Again, this is all emotions. And allowing emotions to have any say in your market timing (or any trading) decisions, guarantees that you you will have even more emotions to deal with. The emotions caused by losses.

Stick to the timing plan. Trade with the trend (all FibTimer strategies are trend following strategies), cut your losses short and let your profits ride, and never, but never, listen to others. Successfully following and profiting from a timing strategy can be accomplished only by you, and you alone.

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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