It's the best kind of problem to have: You've doubled your money.
That's the "problem" my
DailyWealth Trader readers recently faced with aluminum giant
Alcoa Inc. (
NYSE: AA,
Stock Forum).
Back in October, we argued in
DailyWealth Trader that the stock had 100% upside potential. Folks were gloomy on the global economy... and aluminum prices had been falling for more than two years. Things looked so bad for Alcoa, they could hardly get any worse...
And
when things can't get any worse, they can only get better. As expected, sentiment on the global economy improved, aluminum prices rose, and Alcoa soared. In late July, our trade hit the 100%-gain mark.
If you've invested in this great bull market, you may be facing the same sort of "problem."
And now you have a decision to make.
If you've been reading newsletters for a while, you've seen lots of different advice on how to handle this type of scenario...
You could sell half your position. That will put an amount equal to your original investment back in your pocket.
The argument for: Once you've "banked" your original investment, there's no way you can lose money on the trade. And you'll still benefit if the asset continues to rise.
The argument against: You'll reap only half the benefits of any future upside.
I like this strategy for extremely volatile assets. Individual biotech stocks, small resource stocks, and options that you've purchased can lose 30%, 40%, even 50% of their market value overnight. It's a good idea to take some money off the table before it vanishes. And once you're playing with the "house's money," volatility is easier to tolerate.
You could tighten your stop. This will allow you to keep your full position invested, but will kick you out of the trade sooner if the trend reverses.
The argument for: You'll compound your gains if the asset moves higher. (When you're up 100%, the next 1% move higher means a 2% gain on your original investment.) If it moves lower, you'll walk away with a larger portion of your profits.
The argument against: You could get "whipsawed" out of the trade, only to see the uptrend resume without you.
I like this strategy for "boom and bust" assets: individual commodity producers, airline stocks, certain tech stocks, funds of biotechs or junior resource stocks, and so on.
Every boom in these assets eventually leads to a bust. You know the trend is going to reverse at some point. You want to be out with substantial gains when it does. And if the uptrend resumes, you can always get back in.
You could do nothing.
The argument for: You'll compound your gains if the asset movies higher. And maintaining a wider stop will make it harder to get whipsawed out of the trade.
The argument against: If the asset moves lower, you'll surrender a larger portion of your profits.
I like this strategy for assets that have some volatility but a lot more upside potential, like growth stocks. Assuming you set your
position size and
trailing stop at the right points when you entered the trade, this is the "goldilocks" choice: room to profit without too much risk.
(For Alcoa, we're keeping our full position in the trade but we're using a tighter-than-normal stop. We'll continue to ride the shares higher and compound our gains. And if the trend reverses, we won't have to give too much up.)
In sum...
When deciding on an exit strategy, it comes down to weighing the potential for further gains against the potential for a sharp downside move.
For an asset that could easily experience a big drop in just a day or two, the "sell half" strategy is sound. For less volatile assets (like most stocks), holding the whole position with a stop loss makes more sense.
If you're holding a "double," congratulations on a great trade. Now consider what you're going to do with it. The worst mistake would be to have no exit strategy at all.