Trading the Melt-Up? Pros Take Profit
Tuesday, 11/19/2024 09:01
How to trade stock-market surge into 2025...
The SHARP ELECTION rally has given way to some volatility as investors digest the moves, fill some gaps, and nervously wait to see what stocks and sectors bounce first,
says Greg Guenther in The Daily Reckoning.
It's easy to start feeling a little bearish here. The percentage of S&P components above their respective 50-day moving averages recently slipped below 60% as many high-flying names appeared to hit a wall. Smaller stocks, biotechs, growth breakouts – all of these groups were hit hard heading into the new trading week.
Despite the recent weakness, stocks remain on track to eventually bounce and attack their highs. November is a seasonally strong month, especially for small-caps (which have taken a big hit following their election breakout). The same goes for the Dow. Both are outperforming the S&P and the Nasdaq Composite halfway through the month.
We're seeing indexes and key names sitting at key levels. If they bounce, it's game on. If they begin to fail, we'll need to reassess. It's that simple.
But it would be foolish to turn our backs on the bulls right now without any confirmation that the market is indeed breaking down and set to move lower.
My end-of-year stock market playbook is simple: grab onto the plays most likely to melt-up into 2025 and ride them as far as they will take you. In these market conditions, your best bet at booking outsized gains will likely come from the most speculative stocks and sectors.
First, know your market conditions, the first step in any risk management plan. Remember, the market is always changing. Therefore, your trading strategies must evolve alongside the prevailing trends.
For example, a bullish strategy involving any of the speculative growth stocks probably would have failed earlier this year when semiconductors and Big Tech (ahem, NVDA) dominated the leaderboard.
Similarly, it pays to take profits early and avoid chasing some of the market's wilder breakouts when the averages are choppy or uncooperative (like the conditions we experienced in the late summer months).
We've already established that we're entering more favorable trading conditions. Barring a broader pullback this week, we're now firmly planted in one of the strongest trading windows of the year. That means breakouts and big moves in stocks are more likely to extend.
In less favorable conditions, I'm pickier with my trades. If the market is flat or choppy, I'll wait for more confirmation and make smaller trades (usually half-size positions). In stronger markets like we're experiencing right now, I'll take more signals and put on full-size positions.
Once you nail down the market environment and decide on your position sizing, it's time to think about risk. More specifically, when are you going to bail on your trade if it begins to work against you?
Most speculators have tunnel vision when it comes to new positions. They only want to think about potential profits.
But a seasoned trader knows he won't always buy a winner. And the most important thing he can do is protect his account from unnecessary losses.
That's where stop losses come in. I don't care what method you use – whether it's a moving average, Dollar amount, or a percentage stop – you simply have to have some idea of when you are going to cut and run. Most importantly, you should decide on the level beforeyou enter the trade. This way, your emotions won't be getting the best of you and causing any irrational decisions in the heat of battle.
Another great way to improve your winning potential is to sell a portion of a short-term trade when it hits a specific profit target. For options swing trades, this might mean locking in half of your gains after the position has doubled. This gives you the ability to let your trade run with house money.
I'm always sure to let winners run (especially during melt-up season), but not at the expense of leaving open profits unprotected. Professionals understand open profits belong to the market…
Sure, you can probably find some excellent long-term plays to buy and hold during melt-up season.
But beaten-down stocks have the potential to be some of your best performing trades in a frothy market. Not only do you get the benefit of a rising tide – speculators are more inclined to take bigger risks and buy stocks they might normally avoid in less favorable conditions.
These plays can offer big profits over shorter time frames. But there is one catch: many of these lower quality names tend to reverse and underperform over longer time frames. Your best bet is to take profits on these more speculative trades when the market allows.
My colleague Enrique Abeyta shared a helpful rule when it comes to stocks that offer exceptionally fast gains:
If a stock doubles in a day, a week, or a month, you sell some. If it doubles in a year or two, you should add to your position.
I love this piece of advice. Not only is it succinct, it's also accurate. Most incredibly sharp price moves are unsustainable in the long-term. It is highly unlikely for a stock that doubles in a week to consolidate sideways. Instead, it will likely give back a good chunk of its previous move as it works to bleed off the excess momentum.
Events like these can easily shake out the weak hands of speculators who were not buying into the stock for any fundamental reason. Once the quick profits are gone, they turn tail and run.
Compare this behavior to a stock that steadily climbs higher over the course of many months as it beats earnings and raises analysts' expectations. That's the kind of action that can help you confidently add to your longer-term position.
Bottom line: Know what you're buying and when you should take profits.
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