Last weekend I wrote about some market cliches so we could think about their efficacy. While these sayings have become conventional wisdom, the real question for us as traders and investors is are they complete and do they work; do they produce the intended result? This week, I would like to examine a couple more with the same objective in mind. One of my favorites is: "You can't go broke makin' a profit." I always say that to myself after I have gotten out of a position only to see it take off after I exited.
"You can't go broke makin' a profit" is only true if our profits are greater than our losses. The problem with the concept is that it doesn't recognize the importance of letting profits run. No doubt it is better to take profit than suffer a loss, but the real key is when to take the profit. Should we pull the plug and exit a play as soon as it turns profitable? Once there is a profit, what should we do to avoid letting it turn into a loss? How long or far should we let the profit run before we close out? Again, as we examine the statement, it can result in the formation of an exit strategy. It seems to me that we can follow the direction of the cliche by recognizing the importance of keeping a profit so we might want to trail a stop once our position is in the profit column or we may set an exit based on the crossing of a moving average or maybe follow Japanese candlesticks, but whatever we choose, we need to have a strategy first to preserve the profit and second to let it run or at least try to avoid exiting too early.
Another well-known market saying is: "buy on the rumor, sell on the news." I think this one is pretty valuable with minor modification. Buying on the rumor probably works pretty well as long as we hear the rumor and hear it fairly early in the game. Hearing the rumor shortly before the news comes out may not work so well. The theory behind the saying is that the rumor generates excitement and excitement causes movement in the price of the stock. Generally, once the news comes out, the excitement is over. There is no more anticipation because we now have the information; we know the news. Once that happens, the run-up is often over as well and we may see a downturn. I suspect the better saying is: "buy on the rumor if you believe there is a reasonable time before the news comes out and sell right before the news is announced." That pre-supposes we know when the news is going to be announced. In some cases, we may know when the news will be announced, in others, it can only be a guess. In either event, once again, we should have our exit strategy in place before we buy.
Is the trend really your friend and do you earn on the turn? If you're not sick of these cliches by now, we may take a look at those two down the road.
Thank you to the many of you who have bought my book, "Trade Your Way to Wealth." I appreciate your kind comments on the book and genuinely hope it advances your trading knowledge and helps you become an even better trader and investor.
by Bill Kraft, Editor
Copyright 2008, Makin' Hay, Inc.
All Rights Reserved
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