Maximize Your Gains With This Simple Trick
The biggest problem with investing in stocks is not knowing when to buy… it’s knowing when to sell. Or, to put it a better way, it’s knowing how to sell.
You see, anyone can tell that today’s market is overpriced.
The average S&P 500 stock is trading at a price-to-earnings ratio of 22. Historically, they average 15 times their earnings. Meaning, on the most basic level, the average U.S. stock is overvalued by as much as 47%.
You have tech stocks like Alphabet (Nasdaq: GOOG), formerly Google, and Amazon (Nasdaq: AMZN) trading at even higher valuations. Even boring old Dow Jones Industrial Average blue chips like General Electric (NYSE: GE) and Johnson & Johnson (NYSE: JNJ) are objectively overpriced.
But does that mean you should sell all of your stock positions?
It would be nice if investing was that simple. But it’s not.
Stocks can — and often do — remain overvalued for extended periods of time. In fact, they could still go up significantly from here.
But more importantly, even if you would sell your stocks, then what?
If you trade into bonds, you face huge interest rate risk. More than half of the economists on the news these days are expecting the Fed to raise rates in December. If that happens, the value of bonds could fall for the first time in a long time. Owning only those investments could be a serious problem.
On the other hand, sitting on cash or putting your former stock market gains into a savings account won’t do you any good. Rates are still near zero. And when they do go up, it will be a very slow process. The Fed has already made that clear.
You could invest overseas. But then you face more currency risk. The U.S. dollar has been strengthening over the last 12 months. If the Fed begins to tighten its monetary policy, that might get even worse. You don’t want to be caught holding euros if that happens.
So you might just be stuck with stocks… for at least a portion of your investment portfolio. That doesn’t mean you have to risk it all falling apart, however.
The Best Way To Protect Gains In Today’s Market
If stocks do come back down to their historical averages, you don’t have to sit by and watch your gains disappear.
In fact, there’s a very simple tool many professional traders use all the time to prevent large losses and shrinking profits: trailing stops.
Here’s an example of how that works…
Let’s say you got into Amazon at the start of 2015. You timed it absolutely perfectly. The stock has gone straight through the roof, especially compared to the rest of the market, which has been relatively flat so far in 2015.
Now, however, you are a bit worried that investors will begin to take their profits off the table. After all, it’ll soon be the holiday season. And that means it’ll be tax season before you know it. And if you add in the uncertainty surrounding the Fed’s rate decision, those are some nice gains to lock in.
But instead of you joining those exiting an excellent stock like Amazon, you can instead set a trailing stop.
Let’s use Monday’s closing price as our guidepost. AMZN ended the day at $678.99 per share. If you got in at the beginning of the year, you’d be up 119%. So you could sell, lock in that cash… but then what? You run into the same problem we just covered. There’s no great place to keep those gains safe.
Plus, Amazon could continue its rally. The company itself is doing great. Sure, it isn’t turning its record sales into huge profits. But that’s Amazon’s whole game plan. Expansion, expansion, expansion.
So if it goes up another 100%, you’d miss out.
Instead of that, you can have your cake and eat it too. Hold onto your stock, but set up a trailing stop.
If Amazon falls 10% from here, it would be trading for $611.09 per share. You’d still have a gain of 97%.
That’s the advantage a trailing stop gives you. But it gets better.
Instead of simply setting an arbitrary price point to sell, a trailing stop moves with the stock itself.
So let’s say it does continue to rally, to say $750. If at that point it begins to fall, you’ll have locked in 90% of that price by using a 10% trailing stop. Or, to put it another way, your 119% gain today would only fall to a 117% gain.
If shares fall from $750 back to say $500, you’d be selling at $675 per share. That’s your protection.
In today’s market, selling stocks just because they look overvalued is not necessarily the best move. So your best bet is to give yourself a layer of protection.
Hold onto your winners… and let them ride, as they say. But set trailing stops where you can. That’s how you exit your winners in a lose-lose market.
P.S. The billionaire who predicted the 2000 and 2008 crashes is predicting another crash in 2016. How is he preparing? By loading up on 35.7 million shares of a “Forever” stock. Click here to get the name of this billionaire, and the stock.