I wanted to start today with a few pointers on how to handle a
"good" problem that many investors are experiencing right now:
What to do with a stock that, soon after your buy, has zoomed 20%
or more in just two or three weeks.
Paradoxically, it's these types of situations that cause the most
stress and uncertainty. Profits are good to have, but if a stock
goes vertical, you're left wondering how to properly manage your
good fortune. The prospect of making a decision--either sitting
tight or selling--can cause investors to behave irrationally.
The solution, as usual, is to have a plan and follow it
consistently over time. There are only three things you can do
when you get a quick, big winner--hold it all, sell it all, or
sell some and hold the rest. As I've written before, we
prefer one of these methods to the others (the latter), but I'll
review the plusses and minuses of each below.
If you decide to hold all your shares, you should aim for a
bigger gain over time ... but also be prepared for painful
corrections along the way. If your stock runs from 50 to 70
in just a couple of weeks, and you decide to hold your position,
that's fine ... but don't kick yourself if the stock then has a
normal pullback to 58 or 60.
If you decide to sell all your shares up at 70, that's fine,
too--there's nothing wrong with booking some profits, especially
when you get a windfall gain in a short period of time.
However, you shouldn't get upset if the stock pulls back a few
points only to rocket to 80 or 90 in the weeks or months to come.
I actually prefer the third option, which is selling some shares
(somewhere between one-third and one-half of your position), but
holding the rest. This approach not only allows you to book
some profit--thereby rewarding yourself for being right--but also
gives you leeway (because you took some off the table) to ride
your remaining shares through the inevitable correction ahead.
The goal with this third option isn't so much to grab the profit
but to ride out what could be a major, longer-term move by
lessening your risk, which decreases your chances of being kicked
out on a sharp (but normal) correction.
If you're interested in more information on how to handle winning
stocks, check out this brief (about five minutes long) video in
which I flesh out this topic and provide two examples--one recent
and one historic
(First Solar (
back in 2007.
Click here to watch the video.
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Speaking of videos, I've actually been tempted lately (if I could
only find some free time) to produce a concise educational
presentation on the
three pillars of investing results
. I'm referring to your batting average, your slugging
percentage and your turnover.
Your batting average is simply your winning percentage. If
you made 10 trades, and six of them resulted in profits, your
batting average would be 60% (or .600 for you baseball fans).
Your slugging percentage is your average gain on your winning
trades, divided by your average loss on your losing trades.
Using the above example, let's say your six winning trades
brought you a total of $6,000 in profits (or an average of $1,000
per winning trade), while your four losers lost you a total of
$2,000 (or an average of $500 per losing trade). Your
slugging figure would be 2.0--that is, $1,000 divided by $500.
The last pillar is the easiest to grasp--it's simply the number
of trades you make per month (or year, or whatever time period
Obviously, the higher any of these three pillars, the higher your
returns. The more winners you have, the bigger your winners
will be compared to your losers, and (assuming you're a
profitable investor) the higher the frequency of trades, the more
money you'll make.
The tricky part is that these levers often work against each
other. Let me explain.
Let's say you're more of a swing trader, holding stocks for a few
days to three weeks. Well, you better have a pretty good
batting average; the key for your success will be consistently
churning out gains, and doing so often. It's unlikely
you'll have a two-to-one or three-to-one slugging percentage,
because you'll likely be booking both winners and losers quickly.
Conversely, if you're more of an intermediate- to longer-term
investor, your bread and butter will be your slugging
percentage. You always hope to have a bunch of winners, but
the key will be landing a few enormous winners, while cutting
losses relatively short.
Finally, the last lever--your turnover rate--is really something
that shouldn't be played with. If you decide to, say, trade
twice as much, I can tell you right now that your batting average
and slugging percentage will slide because you'll probably be
forcing some bad trades.
The point here isn't to reveal a "best" combination of the three
(there is none!), but instead to start thinking in terms of these
three metrics when evaluating your own results. While you
don't need a spreadsheet that's exact to the decimal point, you
should have a list of your results that you can peruse from time
For instance, say you're in the midst of a trading slump, so one
weekend you start digging into your results. If you notice
that your batting average is way down, it's possible that either
the market just isn't as healthy as it appears, or (more likely)
that your stock selection has gone to pot. If you're
slugging percentage is way down, it's likely that you've been
bailing out of some high-potential stocks too early ... or
letting your losses get out of hand.
Again, there are no magic answers in the market--if there were,
we'd all be rich--but keeping these three pillars in mind is a
creative and also more precise way to evaluate your own trading.
As for my stock idea, I'm going to go with
, a stock that, frankly, I had totally taken off my watch list
many months ago. It was a good winner during much of the bull
market, but after a mega-run, the stock basically topped out last
fall (relative to the market) and has been consolidating ever
The story has always been solid--server virtualization, which is
hugely cost-effective because it allows each server to be used
for many different applications. It doesn't hurt that this
so-called "cloud computing" has become all the rage. But,
while growth was good, it wasn't anything extraordinary (never
triple-digit growth or something like that), and eventually, the
stock's valuation got too big for its britches. Hence the
long period of lagging action, even as the overall market ramped
last fall and so far this year.
However, earnings season has a way of transforming the landscape
for certain stocks, and for VMware, it appears to have done just
that--sales rose 33%, earnings jumped 50% and the firm raised
2011 guidance significantly. Analysts are now looking for
the bottom line to jump 30% this year, and knowing how VMware
regularly beats expectations, that figure could prove
All those numbers are nice, but what caught my eye was the
stock's reaction--VMW surged 12% the day after its earnings
report, and more importantly, volume that day totaled 13.6
million shares. That was more than five times normal and
the stock's largest one-day total since July 2008!
Interestingly, the stock surged right back to its old price
highs, and has since backed off a few points, as many leading
stocks consolidate their recent gains. I think it's
possible to buy a small position (maybe half of the amount you'd
normally buy) around here, and look to average up on a strong
breakout above 99. After a multi-month rest--before the
earnings move, shares had gone nowhere for six and a half
months--it looks as if VMW might be ready for another upleg.
All the best,
For Cabot Wealth Advisory
Editor's Note: Mike Cintolo is VP of Investments for Cabot, as
well as editor of Cabot Market Letter, a Model Portfolio-based
newsletter of the best leading growth stocks in the market.
It's been over four years since Mike took over the Market Letter,
and during that time he's beaten the market by 14% annually (up a
total of 65% since then, compared to a loss of 6% for the S&P
500) thanks to top-notch stock picking and market
timing. If you want to own the top leaders in every
market cycle, be sure to
give Cabot Market Letter a try