Learn to Sell Too Soon

Wednesday's column on the holy grail of trading prompted some interesting dialogue from some of you. I had commented on two opposing market approaches that work pretty well on their own. First, learn to sit tight and ride positions longer than you think you can stand. Conversely, learn to sell too soon.

One reader writes: "I spent time looking at my past trades for the last six months. The conclusion was very simple. If I had hung on, I would have made more money." I suspect that most folks would discover the same flaw in their own trading. We just can't wait to declare victory when a position is moving in our direction and close it for a profit. If we'd only zoomed out first and looked at the bigger, long-term picture, we'd have seen that there was no objective reason to close out that position. We only psyched ourselves into booking the profit.

Now, if we could cut short our losses along with our profits, at least we wouldn't get hurt too badly. But this is not the case with most folks. It's never fun to admit when you are wrong, especially if the admission costs you money. Rather than cutting a loss quickly, it's way too easy to simply believe that you are not wrong but early. So you let the loss run on and on, confident that you'll ultimately be proven right.

Wrong!, as Jim Cramer likes to say. If you hold your positions until it doesn't make sense to hold them any longer, you'll let profitable positions run on and cut losses quickly. But if you ignore common sense and instead succumb to your instincts, you'll probably always do the wrong thing. That's why trading is hard.

Let's look at some charts.

Look closely at General Motors (GM - commentary - Cramer's Take) as it continues on its reversal of a gut-wrenching downtrend. The December low had been running along the lower Bollinger Band, while the early January high failed to tag the upper Band. The subsequent mid-January low barely fell beneath the middle Band while the recent high has tagged the upper Band.

See a pattern here? The stock is working its way upward within the statistical trading range as defined by Bollinger Bands. GM had been trapped within the lower half of the trading channel, but over the past few weeks, the price action is contained in the upper half of the channel. I'd be a buyer on any kind of weakness, with a stop around $22.00.

3Com (COMS - commentary - Cramer's Take) looks a lot like GM. We see a series of higher highs and higher lows. Seems to me that a ramp from $3.50 to almost $5 in less than a month is a bit too late to buy. But I'd sure be looking to buy the stock on any weakness.

I wrote about Google (GOOG - commentary - Cramer's Take) early last week, noting that a two-point trend line wasn't exactly valid. After all, any two points can be connected with a line, but that doesn't make it a valid trend line.

Google finally has fallen to establish the third point of a trend line. Now is where the fun comes in. If the stock closes beneath this trend line, the uptrend is likely to be at an end for the time being, and the next stop would probably be around $300. But if the trend line holds up, then the current selloff is another rare buying opportunity. I don't like predicting stock prices, so I'll just wait and see which way the strength pushes, and follow along.

Evergreen Solar (ESLR - commentary - Cramer's Take) has gained more than 50% over the past month. Isn't it ripe for some profit-taking? I'd use any weakness to buy. However, if the stock doesn't come in within the next day or so, I'd still consider dipping a toe in the water. That way, if the uptrend continues, you're involved. And if the stock does instead pull back, you can add to your position. (Note that this scaled entry strategy is different from making the trading mistake of doubling down because you can't admit you're wrong.)

SiRF Technology (SIRF - commentary - Cramer's Take) once again pulled back to the middle Bollinger Band before hitting a new high. The stock looks strong now because the volatility over the past few months has been pretty low; there is significant pent-up energy to burn off. The safest stop to protect against a trend reversal is clear down beneath $30. That's a long way to fall before finding out whether you are wrong. So any buy now should just be a partial position until $35 falls as resistance.

Be careful out there.

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Dan Fitzpatrick is a freelance writer and trading consultant who trades for his own account. His columns focus on quantitative strategies for trading and investing. Fitzpatrick has lectured throughout the U.S. on the proper use of technical analysis and options trading. At time of publication, Fitzpatrick held no position in any stocks mentioned, though positions may change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While Fitzpatrick cannot provide investment advice or recommendations, he appreciates your feedback; click here to send him an email.