I have a confession to make. One of the key ways I break the rules Doug Casey taught me is in the area of taking profits.
Longtime readers will know that for decades, Doug has preached selling half on the first double on any given speculation. When you’re up 100% and you take profits, you get your initial investment back and are left with just as much money in the play. With your cash back in the bank, you can rest easy and ride out whatever happens next—whether it’s a moonshot or a smoking crater in the ground.
I accept this logic.
Generally speaking, it’s a great idea. Profit taking is a critical part of successful speculation. Without it, gains can slip through our fingers and we risk becoming nervous wrecks.
But when it comes to specific cases, I’ve found that one size doesn’t fit all situations. Blindly following the formula could be dangerous—or reduce the upside without need.
For example, there were times when a stock was rising more than the company’s results merited.
Mind you, I’m not just saying the stock was overvalued. That happens all the time—and doesn’t stop a stock from getting even more overvalued in today’s world.
I’m saying that, for instance, grab samples on the surface of the earth do not a valuable mineral deposit make. Investors chasing a stock way up on such results are asking to get hurt. That can happen even without management fanning the flames.
There were times when a stock had gotten way ahead of itself and was ripe for a fall, so I recommended taking profits early, not waiting for a 100% gain. (Note that this is very different from selling because the company failed to deliver—that’s cutting your losses.) As I think back on the years, remembering the number of stocks that delivered big wins, but not quite a double, I wish I had done this more often.
On the other hand, there were times when a stock was really on a tear, delivering spectacular, value-adding results in every press release, and there was no reason other than Doug’s rule to take profits on 100% gains. Now, it’s true that you never know when a stock is going to go into reverse, the market is going to change, or a sudden fatal event is going to occur. So, playing it safe and getting one’s hard-earned cash back out of potential harm’s way is not a bad default plan. But when everything is going great, the people are solid, the country risk is minimal, the market is rising, and so forth, there’s an alternative to selling half on the first double. We can switch to using a trailing stop loss (TSL) instead.
I want to be very clear on this: stop losses are usually a terrible idea for the kind of tiny junior companies I speculate on. Most are so volatile that what seems like a sensible stop loss can be triggered for no good reason. Such stocks can drop dramatically on low volume, just because a single shareholder got a margin call or some trader got a decimal point wrong. A stop loss in such a situation could have me selling at exactly the wrong time, for the wrong reason—perhaps even at the very best buying opportunity for the whole story.
Putting a TSL on a winning position is different. Instead of selling half of a position simply because it’s winning, I can let it ride for as long as it’s rising. I might set a tighter TSL, say, 5% or 10% for a stock that’s rising steadily. It could be looser, say, 25%, for a stock that’s staggering upward with more volatility.
Either way, unless the stock tanks the moment I get my first double and don’t take profits, I can increase my return. The longer I let my bet ride before taking profits, the greater my returns. And if it does tank right away, the TSL still locks in a win.
Remember; we’re talking about a decision made at a point when I’m already up 100%. If it drops 5% or 10% from there—or even 25%—it’s still a big win. I can decide at that point if I want to recover all my initial investment, leaving a smaller amount of cash in play, or take just the profits, leaving my initial investment in play. That would depend on the reason for the stock’s retreat and my perception of the risk going forward.
But this is rare. Mr. Market doesn’t know or care when I bought or at what price. I’ve never actually seen a stock tank at the very instant I got my first double. I have seen it happen soon after. I can think of one case in the last 14 years in which it happened within a couple days. In by far the majority of the cases, the stock ran for some weeks or months before peaking and correcting. In that majority of cases, I would have made more money by using a TSL instead of selling half on the first double. I wish I had thought of this sooner.
To be fair, Doug doesn’t follow the formula religiously himself. I’m not bashing him—or blaming him. I made my own calls. And his rule, as I say, is a good default plan to start with.
That said, going forward, I do intend to use TSLs where appropriate, rather than a one size fits all “sell half on the first double” rule.
One more thing…
Taking profits is one of the hardest things for speculators to do. We work so hard to get a big win, it’s almost painful to sell when a stock is hot. I understand. But it’s absolutely necessary.
We are speculating.
There are no sure bets. Whether you opt for caution and start taking money off the table sooner, go with the default of selling half on the first double, or try my TSL approach, you absolutely must choose a system and stick with it.
Discipline pays.
