For active investors, getting out of a stock position is at least as important as getting in, and success requires discipline.
Cabot Wealth Network was founded by Carlton Lutts, an engineer by training – and a truly delightful person. Carlton applied engineering methodologies to investing, scanning charts, studying the financials, and scrutinizing the management teams. In fact, he created many of the investing systems Cabot’s analysts still use today, although many have evolved over the 50+ years.
And what makes a system work?
First, it takes discipline to create and improve upon an already-effective system; second, it takes disciplined analysts to employ that system to generate useful and profitable insights, education, and recommendations; and finally, it takes disciplined investors to apply those insights and recommendations.Together, these disciplines have helped our subscribers make money for more than 50 years.
Now, don’t get me wrong. We don’t always get things right. Our systems for stock picking aren’t perfect (none are). And our judgments and timing can be off at times as well. There is always risk in investing, and anyone who tells you otherwise is either lying or doing something illegal.
But in addition to their proprietary stock picking screens and filters, each of our analysts applies some sort of system for cutting losses and taking partial profits as a way to lower risk. These may vary a bit depending on their investing strategy. For instance, stop-losses in more volatile small- and micro-cap stocks usually need to be looser to keep from stopping out too easily.
That sort of discipline can make a huge difference. As entrepreneur and author Jim Rohn said:
“Discipline is the bridge between goals and accomplishment.”
For example, our Chief Investment Strategist Mike Cintolo saw the implications of a number of trendlines and recommended that his subscribers move largely to cash in advance of the 2008–2009 financial meltdown. His subscribers kept their powder dry while the market crashed and burned, so they were ready to jump back into the market relatively early, buying up stocks that were now heavily discounted from where they had been.
So, it always catches my interest when I hear from a subscriber who tells me they followed our advice but didn’t make money, or that they even took losses.
When I probe a bit, what I hear more often than anything else is that they bought when our analyst said to buy, but they didn’t sell when we said to sell.
One thing to know about our analysts is they aren’t trying to buy at the absolute bottom and sell at the top. While that sounds nice theoretically, timing like that requires luck, and luck is not an investing strategy. Rather, we wait to see an uptrend getting established and buy as quickly as possible.
Similarly, after an extended uptrend, we will typically sell portions of our holdings to take profits off the table and reduce downside risk. And when the indicators start to look bad, we may sell out of a holding completely even if there ends up being some more upside that we miss.
Having purchased the recommended stocks when we issued a buy rating, why don’t they sell when we change our recommendation to sell?
What I often hear is that they felt we were selling too early, so they didn’t take partial profits when we suggested selling half of the holding. And they continued to hold the stock even after we had changed our recommendation to sell.
Again, going back to our disciplined strategy, we’re not trying to sell at the very top. It’s almost impossible to get that timing right, and even if you do, it’s pure luck and not something you can count on doing again.
As a result, we will often sell out of a position only to see that stock continue to go up for some period of time. Perhaps it rises another 10% or 15% over the next few weeks. But then the correction comes, dropping the price by 30% or 40%. Too often, the undisciplined investor gets greedy… and gets burned.
In short, we’d rather capture 75–80% of the upside and reduce our downside risk at the same time, then take our profits and move on to the next trade. We’re not going to obsess about having left a small portion of the money on the table.
Here are a few rules to help you improve your investing success by being more disciplined:
- Have a plan each time you buy. What’s your target price? When will you take partial profits? What’s your tolerance for loss if the price drops, and is your stop-loss set accordingly? (Don’t set too tight a stop-loss or you’ll constantly get stopped out of stocks.)
- Have a reliable source of information and insights you trust. Listen to what they have to say and what their investing philosophy and strategy are.
- Commit to your system completely. Buy when they buy. Hold when they hold. Sell part when they do. And sell completely when they do.
- Understand that no system is perfect.There will be surprises and misses. Don’t overreact to losses. Don’t obsess about squeezing out every bit of upside profit. And don’t panic just because you take a loss from time to time.
Stay disciplined.