Taking Profits - Definition
When you start out in the trading game, you often will hear a number of pearls of wisdom. Keep your losses small, let your winners run, no one ever went broke taking profits. These anecdotes make trading sound so easy. One of the biggest reasons for so many losing traders on Wall Street is the fact they take profits too early. If you continuously take profits before you let your harvest come in, you will go broke.
Example of taking profits
First off trading is a game of odds. Anyone that tells you otherwise is either delusional or not a seasoned veteran. Since it is a game of odds, much like a casino, the only way to win is to have your winners be bigger than your losers and to have more winners. This sounds simple enough, but remember when you are wrong, you are not only in a losing trade, but you also have to pay commission. For day traders, this fact is all to critical to your bottom-line as you are looking for relatively small price fluctuations to make a profit. So, how do people go broke taking profits? Let's say Trader A purchases 200 shares of MSFT at $50 and pays 4 dollars in commission. The stock runs up to $50.25 and Trader A sells for a quick half of a percent gain. This sounds easy enough right? Well Trader A then puts on a short of 1000 ATVI at $10, but the stock quickly rallies and Trader A has to cover for a half of a percent loss. Trader A invests 10k on all of his transactions, but since the ATVI trade commissions are $16 dollars due to the 1,000 share lot. So, while the percentage gain/loss for the MSFT and ATVI trades are exact, Trader A will actually be down $12 bucks on these trades due to the commission costs.
I know this all sounds really simplified, but what ends up happening over a 1-month period, is that you will end up grinding it out and not having any breakthroughs in your trading profits. This grinding cycle leads to stress and poor trading habits. You as a trader have to determine some method or means of allowing yourself to stay in winning trades, while limiting your risk. Trader A in the above example sold out the minute a half of a percent target was hit, but what if the stock was preparing for a move to $52, or $55? The answer to this question is that you don't know. But what you do know is that trading is a numbers game much like the casino, so if you structure your strategy to allow you to eat the big winners (whatever a big winner means to you), you will be able to achieve much greater success than to constantly sell a stock for the simple fact you have made a profit. If you get one thing out of this article, you must remember that you only sell a stock when you have a predetermined reason for doing so. Never sell a stock just to take profits, remember your security could end up going much higher.