A couple weeks ago, I explained why it is imperative to run trailing stops behind your individual stocks.

Sell stops ensure that your capital is protected and your profits don’t slip through your fingers.

However, one subscriber took me to task, saying that a trailing stop guarantees you won’t “sell at the top.”

Quite true.

However, “selling at the top” and its corollary, “buying at the bottom,” are not realistic investment goals. Here’s why…

The Danger of Selling High and Buying Low

For one thing, you never know the top or the bottom until you’re looking in the rear view mirror. And given enough time, all-time highs and lows are usually exceeded.

For example, you may sell a stock at its 52-week high – not a good idea since you should always let your winners run – and find that it goes on to double or triple from there. Likewise, if you buy at the all-time low, the stock may head still lower (after all, that’s the direction it’s heading).

Our trailing stop policy works, in part, because it accepts the uncertainty that is an inevitable part of equity investing. Sure, you may get lucky and buy at the bottom or sell at the top from time to time. But hoping to “get lucky” isn’t much of an investment strategy.

And there’s yet another iron-clad reason to use trailing stops…

How Trailing Stops Can Maximize Your Gains & Mitigate Your Losses

It’s a little-known but depressing fact that the vast majority of individual stocks post negative returns over the long run.

This may come as a shock to those who’ve been told that equities are the very best long-term investment.

• But research by the investment management firm, Dimensional Fund Advisors, found that form 1980 to 2008, the top-performing 25% of stocks was responsible for 100% of the gains in the broad market.
• The bottom 75% of stocks collectively generated annual losses of 2% over the past 29 years.

It’s pretty sobering to realize you were three times as likely to own losing stocks as winners.

However, this data makes the fundamental assumption that you actually held all these stocks over the entire period.

Many stocks make spectacular runs before crashing and burning. By using a trailing stop, you could have participated in an awful lot of upside without sticking around for the Battle of Little Big Horn.

Likewise, even if you picked a stock that went south immediately, a trailing stop would have kept your losses small and acceptable.

Don’t Argue With the Market… Use Trailing Stops Instead

The bottom line is this: Anyone can plunk for a few shares. Getting out at the right time is the true art of investing.

The key is to make sure you’re cutting your losses and letting your profits run.

Emotions like fear and greed (and hope) can prevent that. But trailing stops enforce a discipline that takes the emotion – and the second-guessing – out of the investment process.

Understand that market prices reflect facts about a company better than opinions. So don’t argue with the market.

When you buy a stock, enter a trailing stop below it to protect your principal. And as the stock rises, keep raising the stop to protect your profits.

This is the best way for you to minimize your losses and maximize your gains – even if some of the stocks you own are on their way to Waterloo.

Good investing,

Alex Green

Source: Investing Without Trailing Stops: Here’s Why 75% of Stocks Are a Sucker’s Bet