Today’s Army is more rewarding than my Army.
New recruits get enlistment bonuses up to $50,000. That’s on top of regular pay. Some career soldiers qualify for more than $80,000. (Back in my day, we got nothing.)
My stepson recently collected his bonus, and decided to start trading with all that new money.
When it comes to buying, he’s great. He has a knack for finding companies that will “disrupt their industries.”
At least, that’s what he says when he calls to tell me about his big wins.
But, sooner or later, those wins slip away from him. Gains turn to losses.
I see this happen all the time. Traders focus too much on buying the right stock, and they forget all about this…
Are You Buying a Stock… or a Story?
My stepson isn’t so good at selling. He holds long past the top.
And he’s not alone. Plenty of traders are unwilling to sell because they “believe the story.”
Peloton (PTON) is a great example. The stock gained more than 800% in the pandemic shutdown. At its peak, the price-to-earnings (P/E) ratio was 459.
Peloton is a niche product. It will never be profitable enough to justify a ratio of 50, let alone 459. A ratio that high indicates triple-digit profit growth would last for years.
But traders believed the story. They thought these expensive bikes with hefty subscription fees would replace gyms.
They failed to realize that pandemic fears wouldn’t last forever. And sure enough, when the world returned to semi-normal, Peloton crashed 95%.
On the way down, many traders told themselves it was only a dip. They refused to sell, and their gains turned to brutal losses.
This is why traders buy stocks, not stories.
And we need to have a plan in place for when to sell those stocks. The bubble indicator I shared yesterday can help with that:
(Click here to view larger image.)
Remember, the blue line is an upper Bollinger band, drawn 1.5 standard deviations above the 200-day MA.
The red line is the lower band, using a 20-day MA and 1 standard deviation.
When the red line is above the blue, we’re in a bubble. When the red line falls below the blue line, it’s time to sell.
PTON began trading in September 2019. Since the blue line tracks the longer-term trend, it needed a few months of data to be drawn.
But as soon as it had enough data, it warned that PTON was in a bubble.
After a brief sell signal in November, the bubble resumed. This indicator isn’t perfect, but it clearly signaled the top in February of 2021.
And that’s far from the only bubble it caught…
See, I tested this indicator on all the stocks in the Nasdaq 100 Index. The tech stocks in this index often trade in bubbles.
Over the past 10 years, 90 stocks in the index entered a bubble. My indicator was profitable on all but 13. For the remaining 77 stocks, you would have sold with a gain.
Meanwhile, the index fell as much as 83% in that time period. Many individual stocks sold off even more than that — some falling all the way to 0 after entering bankruptcy.
Many traders didn’t have rules in place for when to sell, and they paid the price.
So before you place your next trade, sit down and think about your plan for selling. Don’t get swept up by a stock’s “story.” Define your sell strategy, and follow it.
After all, buying a stock gives you gains. But selling lets you keep them.
Senior Analyst, True Options Masters