This Share Trader Mistake Could Cost You a Fortune!

The letters ‘GFC’ have global acknowledgement. And rightly so. It was one of the biggest financial meltdowns of all time.

Some resources say that 45% of global wealth had been lost by March 2009. Trillions of dollars increased in smoke. Many people lost everything.

The social cost had been overwhelming. Global job deficits were close to 27 zillion. Around 250,000 of those were Australian jobs. It had been a time of hardship and low self-esteem for many.

You can be sure of this: the actual GFC is a crash people will talk about for years to come.

But not today. I will tell you a story from an additional crash. It was only 7 years earlier. Yet it already draws a blank with regard to younger traders.

What I’m talking about is the Dotcom era. This is one of the great boom/busts of our time. And it drew in retail traders for the first time.

I remember watching a current affairs program of the day. It was profiling a brand new age trader — an everyday mum. Her classic line was ‘I can make $10,000 while making the kids’ lunch‘.

Then there was the actual host of a popular early morning breakfast show. When the accident finally came, he had to take the day off to ‘attend to his portfolio’. It was speculation gone wild.

Many were hailing it a new era. They said it was different to other booms. The thinking was: technology would forever boost growth. Old school stock analysis was supposedly obsolete.

But you know what. It had not been different — it never is actually.

You see, markets move in large recurring cycles (my friend, Phil Anderson, has an excellent service about cycles). The problem is that most people just focus on the immediate past. They just don’t see the overall patterns.

Let me personally tell you a story about one of these simple people. His name is actually Tony. He was a stockbroking customer of a colleague.

Tony was typical of many part-time speculators. He would take large positions in a few companies. The strategy was then to hold upon and hope they increased.

Now Tony had been my colleague’s client for a couple of years. He had a few decent wins. But some large losses were adding up. Their account was slowly heading south.

It was now late 1998. And the internet trend was about to hit top equipment.

Tony called my colleague. He said ‘buy me 20,000 shares in Sausage Software‘. Sausage was an emerging IT company. It’s shares were worth about $1.

Sausage shot to $2 a reveal within a couple of months. Just 3 months more and it was closing within on $10. Tony’s stake was quickly nearing $200,000.

Have a look at the next chart. This is what an 8-fold gain looks like.

My colleague advised Tony a2z to sell half. But he or she wouldn’t hear of it. The media was in a frenzy over Sausage. And so was Tony.

Sausage was your classic trend following stock. This ran, and ran, as well as ran.

The shares hit an optimum of $41 in March Two thousand. They had gone up 40-fold in just Fifteen months. It was what we call a 40 bagger.

Tony had run a $20,Thousand stake into a profit of around $800,000. He had also opposed all his broker’s calls to sell. Tony did exceptionally well to get this far.

There only agreed to be one more test — his leave strategy.

Think about this for a moment. How would you react?

It’s not as simple as stating sell. No one knew $41 had been the peak. And anyone prone to take profit had most likely sold out long ago.

Let me tell you what Tony did. He held on.

Sausage shares were back at $26 within just fourteen days. Tony’s $800,000 paper profit had been now worth $500,000. He saw $300,000 evaporate before his eyes.

My colleague was still being pressing Tony to sell. But there was a problem. Tony was now focusing on the $300,000 he had ‘lost’ — not the $500,Thousand he still had.

Many investors make this mistake. They location more value on what they’ve lost than what they still have. The need to get back to even overrides the necessity to get out.

Tony held, and held, and held. The shares were below $20 in times. Within two months they were below $10. And by 2003 they were buying and selling for less than $1.

Have a look at this chart — it’s a wipeout.

Source: BigCharts

It all comes down to this. A good entry strategy only gets you so far. You also need a plan to sell. This is what separates the plodders from the entertainers.

Let me show you what could have been. This is what happens when we apply Quant Trader‘s exit strategy to Tony’s trade.

Look at the difference a robust selling technique makes. It captures all but the final manic stages of a huge bubble.

An excellent real-time example is the Chinese market crash. Viewpoint is split on whether this is a short-term correction or a long-term bust line. The fact is, no one knows. This is exactly why you need an exit technique.

Quant Trader had exposure to the growth through the AMP Capital China Development Fund [ASX:AGF]. The system rode the trend up. But it won’t ride the popularity all the way back down.

Have a look at this chart.

Do you see the red dotted line below the stock price? That’s the trailing stop — it’s the point where we exit a trade. It ensures you don’t end up like Tony.

A looking stop won’t exit at the very top — that’s for the crystal golf ball gazers. But it does the next best thing. This gets the big middle area of the trend. That’s where you make the money.

Successful trading requires multiple strategies. You not only have to get to the big moves…you eventually have to get out. The trailing quit is the best way I know to get this done.

Until next week,

Jason McIntosh,

Editor, Quant Trader

Editor’s note: The basis of excellent trading is to stay with shares that are rising. But that’s insufficient. You also need to kill off the trades that are eroding your capital. Fortune favours the actual trader who masters this straightforward concept.

Quant Trader does this by utilizes algorithms — a collection of mathematical formula. These allow for consistent as well as unemotional trading. You can read more about Quant Trader’s algorithmic methods here.