SHOP has had an incredible run. Since January the price has risen from $130 to current levels around $320. Many shareholders are wondering if it is time to sell. Wall Street feels that it is fairly valued. 28 firms follow SHOP and the average price target is $325. But then again, these highly paid pros that make these predictions are often wrong. If you own this stock you may be asking yourself what to do?
The vast majority of discussions about investments are about what to buy. Lists of stocks to buy and stock recommendations are all over the financial media. I very rarely see any discussions or advice concerning selling or what stocks to sell.
This is ironic because knowing how to sell is more important than knowing what to buy. When investors hold a stock they become fearful. If the stock goes down they are afraid of taking a loss and if it goes up they become afraid of losing their profit. This causes people to sell their winners too soon and to hold onto their losers for too long. Sound familiar?
When people become afraid of something their adrenaline levels rise. This evolutionary response to fear may have benefited humans 20,000 years ago if they were being chased by a Saber Tooth tiger or hunting a Wooley Mammoth, but it is not beneficial to trading and investing. This adrenaline rush causes people to make irrational decisions. This is why computers and algorithmic trading dominate the markets. These computers do not have emotions so they do not make the same emotionally driven mistakes that humans do.
This leads us to the most important rule of successful trading or investing. This is that you should not enter a position unless you know where you are going to sell. You should know where you will sell to take your profits and you should know where you will bail out and take your losses. If you have these levels clearly defined it will help prevent you from losing money by making an irrational decisions. If you do not know how you are going to sell then you are just guessing. You would be better off at a casino. You’ll still lose money, but at least you can get free drinks!
Here is how I would apply this to SHOP. One possible profit target would be $330. This is a logical target because it was where the high was on June 20th. A second possible way to profit is to sell it when it becomes overbought again. As you can see on the chart, the last 3 times SHOP became overbought it was a selling opportunity, The stock trended lower afterwords each time. A third possible sell for profit target would be $325, the average price target of the firms that follow it. It really doesn’t matter which target you use. The important thing is to have a set target or sell rule so when SHOP gets to your level, you will know what to do. This will help prevent emotional mistakes.
For determining where to take a loss, the logic is the same. Which rule or target you use isn’t as important as having a set rule or target. The idea is to take the emotions out of it. It isn’t to try to mastermind the markets.
A trailing stop is one way to do it. This would be to sell it if it falls a certain percent. For example, if you have a trailing stop of 5% you would sell SHOP if it fell to $304. Another potential sell technique could be to sell if the uptrend breaks. There has been a well-defined uptrend here. The breaking of this trend-line could be a signal to sell. A third method could be a moving average crossover. For example, sell if the 10 day MA crosses down through the 20 day MA.
If you understand that we humans have not evolved in a way that is conducive to successful investing you’ll dramatically improve your results. Our emotional response caused by the fear of losing money causes us to make irrational decisions. A way to deal with this is to remember and implement the most important rule of investing. You should know where you will sell to take your profits and where you will bailout and take your loses before you buy a stock.