Why Lock in Gains? — This Happens

You create dry powder and opportunity.

Why Lock In Gains? — This Happens

By Charlie Whooph

Charlie Whooph operates whooph.Substack.com  where he shares:  TWO swing trades per week (FREE): Examples, How we use market structure, How-to consistently time swings to scale income. Daily since 1999.

Then Opportunity Happens

When we lock in gains at an appreciable level opportunity becomes available.

Capital preservation ratios compounding over an over is reason enough!  Where the median retirement 401k balance ages 55-65 is $95,600, which happens to be in the United States, we need to reassess our investing methods.  

Shortly, below I’m going to share what proper capital preservation which naturally occurs in taking profits at advisable levels looks like. Stay with me. 

Expert Trader Rules

Market experts and traders often cite the 20%–25% gain as a common trigger to lock in gains. So according to the RULE, “When a stock climbs 20%–25% from a proper “buy point” (the ideal price to purchase based on chart patterns), it is often a good time to sell to avoid corrections.” Investors Business Daily founder, William O’Neil is one of those long term swing investors who advocate strategically locking in profits.

Why 20 - 25% ?

When company earnings grow stock prices generally rise. But when a stock price above some level of appreciation that price becomes unsustainable. Hold that thought. I know what you’re thinking — table that opinion. 

For now, we’re interested what the Market thinks. And ‘What the Market thinks” can be seen at any point in time on Hourly, Daily, or Weekly chart any timeframe. Hence, the incisive question asked repeatedly before Charlie Whooph’s own swing trade or investment:

What precedes every reversal or swing?

Charlie Whooph has been swing trading market tells since 1999.

Suffice it to say, patterns in growth stocks and behavior psychology suggest odds are staunchly against one’s “hold forever” posture as continued price appreciation more than 25% above the ideal purchase price is unlikely, without a pullback or correction. This is historical fact. Thus, it follows that the market only trends higher 20-30 percent of the time.

And then Mean Reversion, equivalent to gravity… happens. Most often if you know what to look for in the price chart, if you’re curious enough, you’ll be able to learn the skill: See what precedes every price reversal, which hacks away gains like you never owned them!

Let’s Quantify Taking Profits

What’s it worth to lock in profits?  If I could regularly preserve gains, thereby creating the option to buy lower in a correction using some simple popular method. 

SPY Corrections & Bear Markets over the last 10 Years:

We’re not promising you’ll achieve the following multiples of your 401k. Just a fun, edifying exercise. Surely you’ve wondered, “What if I’d had cash?” known by professionals as “dry powder” which buys you like the rich THE OPTION to buy bargains at the bottom.

Let’s just go through the exercise. Were you to sell at some point before these corrections, preserve your capital, and hypothetically re-purchase at a low, what is the multiplier that might be possible. And then let’s apply that multiplier to your 401k investment capital, repeatedly every 10-35% correction.

Trajectory

Okay. There actually is an exception to Lock-it In @ 20-25% - Trajectory. 

A stock or fund that rises this much in a just few weeks may be an exceptional winner, allowing for a longer hold time. How do the pros handle these out-performers? — The 8-Week Hold Rule

The 8-week hold rule: 

O’Neil handled this exception to his 20-25% Rule as follows: If a stock gained 20% or more within three weeks of a breakout, he advised holding it for at least eight weeks

The Pros

This is incredible…

According to market trading professionals, the market spends approximately 70–80% of its time in a ranging or consolidating phase, which includes swings, reversals, and retracements. Only 20–30% of the time is spent in a strong, trending phase! This ratio is known as the "market paradox": trends are what traders want to catch, but ranging is the norm. 

So, when you do catch a nice ride like 100% over 2 years, ask yourself this:

• Can I be okay losing this hard-earned $50,000?

Gains are an illusive and precarious thing.

• Which is harder?  Making it, or KEEPING it.

Growth Investors

Growth stock investors following the methodology of William O'Neil, founder of Investor's Business Daily, typically sell a stock when it has gained 20 to 25% from its correct buy point. O'Neil developed the popular CAN SLIM system.

Why the Rule Works

O’Neil’s research simply shows that growth stocks “pull-back” after reaching this 20-25% psychological level. In a pull-back price returns to prior lower levels, testing these levels because everyone’s selling. (But not you.) 

A decision to sell, take profits is a decision to keep your gains. Why is that important?  It creates opportunity. Dry Powder.  “If I had $50,000…I’d buy X.” Well, even the rich don’t always “have” the dry powder funds to buy lower. They create it by selling appreciable gains! 

Selling does TWO things: 1) locks in your 401k balance and 2) frees up $10k, 50k, 100k of capital to be redeployed for new fire house sale opportunities, bottom of a crash or correction.

Who Should Lock-in Profits?

According to the very experienced long term swing investors and traders, the good practice of taking profits when a stock has gained 20 to 25% should be deployed by: Growth Investors, Swing Investors, and Swing Traders.

How to Implement Profit-taking

• Scaling out: 

This method involves selling portions of your position at different price levels as the stock climbs. For example, a trader might sell one-third of a position after a 20% gain, another third after a 35% gain, and let the remaining shares ride. This approach balances securing profits with capturing potential additional upside.

• Trailing stops: 

For investors who want to maximize gains on a strong uptrend, a trailing stop-loss order can be effective. This stop order automatically moves higher with the stock price, locking in profits. One investor may set a trailing stop 6% under the continual stock sale price, which follows the stock price and automatically sells. If the price reverses by a predetermined amount, the stop is triggered, and the position is automatically sold.

• Fundamental shifts: 

Taking profits is wise if a company’s fundamental story changes for the worse. Declining sales, bad economic news, or a change in management can all signal that the stock’s growth potential has deteriorated. 

• The Whooph Method

Charlie Whooph operates whooph.Substack.com  where he shares:  TWO swing trades per week (FREE): Examples, How we use market structure, How-to consistently time swings to scale income. Daily since 1999. Charlie Whooph offers a FREE 5-Part Course teaching you how-to see and time a market swing. 

How can an investor otherwise know when an equity’s trend is “done”. The market has run its course and is showing signs of weakness. The answer may not be obvious!  HINT:  Never mind my uncle’s opinion…

    - What does the market think?

    - How does the market tell?

    - What precedes every reversal?

Divergence

And so says the principle of Diverging Signals. Take another look at the example chart above for SPY. Notice the disagreement between Price and the MACD Indicator. “What precedes every swing or reversal?” How did the “market tell” us in this SPY chart?

SCENARIO:

Price is vaulting happily higher and has put in consecutive higher Price highs. Peachy!  Novice retail buyers are continuing to pile into the stock. Maybe a lot of broad investor exuberance. Marked momentum.

Yet, unbeknownst to the average trader or investor, a correction…is just around the corner.  You’d never know it, at first glance! Were it not for the market tell - disagreement.

What? Yep, the market is already sending signals well before the reversal. Of course, some catalyst will take center-stage and spark massive selling. “But I just read…an article.” Never mind the bullish article you just read!  Let’s ask, “Who likely wrote that article?” 

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30 million new trading accounts were opened during 2020-21 (Covid). 

What happened to them?   90% lost 90% of their money in 90 days.

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And yet 1 out of 5 will acquire a method and do well. 

Whooph says:   A reversal or correction in something in some timeframe is being telegraphed by the market right NOW, to anyone able to speak Chart.

Well, I’m more like Warren Buffett… 

All we Investors have our reasons:  “I’m a long term guy.” Sure you are. “Is it harder making it, or KEEPING it?”

Some subscribe to Warren Buffett’s “buy and hold” mantra, albeit without the Berkshire Hathaway research team and copious cash to buy correction bargain lows. “I’m a Buy and Hold investor.”  I know.  I’ve been that. 

We’re going to evaluate this practice of Buy and Hold, including the two ELEPHANTS in the room which the average investor is inclined to dismiss.

We’ll briefly showcase five experienced investors and one Buy and Hold investor.

Whooph will also corroborate their insights with a question: What if you could see a correction is coming? Would you lock your profits in?

Famous Swing Investors

Well-known investors typically align with either a long-term buy-and-hold philosophy or a more active, short-term trading style. 

The concept of "long-term swing trading," rebalances on two impetuses: changes in underlying fundamentals AND profit-taking from long-held positions. These investors deploy a flexible strategy.

Peter Lynch

During his tenure managing the Fidelity Magellan Fund, Peter Lynch used an adaptable strategy often described as "chameleon-like". While known for long-term growth stock picking, he would also sell when a company's story or fundamentals changed. 

On Profit-taking: Lynch would sell a position if its earnings and growth story deteriorated or if it became overvalued. 

William O’Neill 

Founder of Investors Business Daily, William O’Neil, developed with the principle of taking profits at 20-25% from ideal or recommended price levels. O’Neil was known for his CAN SLIM investment style which involved selecting stocks based on both fundamental and technical analysis. He relies on momentum investing, strict risk management, chart analysis, and disciplined selling.

Paul Tudor

One of the most successful hedge fund managers in the world. Studied patterns and famously anticipated Black Monday when the Dow dropped a whopping 22% in one day. Tudor anticipated the swing, rode it, and netted a $100M profit.

Nicolas Darvas

Darvas became one of the most successful traders in the 1950s developing the Darvas Box Theory strategy that combined fundamental analysis with technical analysis. He focused on stocks showing increases in Volume and Price.

Others:

Bill Ackman

Carl Icahn

Ben Graham

The List of Dissenters

Warren Buffett

Buffett is famously a long-term, buy-and-hold value investor who focuses on the long-term fundamentals of the company, not its short-term price changes.

He says to focus on the business, not the price: His famous holding period is "forever." His mantra has for a long time been, “ Hold it forever.” He sells a stock only if its underlying business fundamentals permanently deteriorate or if he finds a significantly better opportunity. 

But wait, Buffett hasn’t always held to his current BUY and HOLD practice…

When he began, Buffett had only a precious, paltry $15,500 to invest. As with any of us, fear of losing it…was palpable! And so it was in 1952.

GEICO (1951 and 1976) 

In 1951, Buffett invested 65% of his capital, $10,000 at $27 per share in this company and sold for a small profit in 1952 freeing up cash for later purchases. Why?  For he has a mantra now, “Hold forever”!  No, not at that time. And, let’s be accurate, his mantra is: “Hold forever, unless…something changes.”

In 1952, he SOLD, which he says was “a mistake”. Hey, hey, hey, hey! “Now, Warren, some might considered that opinion Monday morning quarterbacking.” …Not me, of course, but some.

I would have to assume Buffett SOLD on the information he had at the time, good risk management, and a healthy fear of losing his 50% profit of $5,000!  Not to mention the $10,000 he started with. So, Warren sold for the $15,000. 

For all intensive purposes, it was a long-term swing trade for profit-taking.

One might surmise, the sting of regret for not holding the initial GIECO position, which he says would have been worth $1.3 million in 1976, may have cemented Warren Buffett’s ultra-conservative “hold forever” practice he now advocates.

Classic long-term Swing Trade, says Whooph.  And incidentally, Buffett re-purchased GEICO on a 19-year swing to the LOW of $2. — Dang!  If we were talking the same $25,000 rotated to CASH in 1952, I’d say this $2 price from the initial $27 was a heck-of-a-nicely timed long-term swing trade.  But, that’s me.

On the record, Warren Buffett advocates “hold forever”. And equates selling a great company to lock in profits is akin to “watering the weeds and cutting the flowers.”  Unfortunately, there are two ELEPHANTS in the room, that perhaps you’ve already noticed.

Two Elephants in the Room

The ugly fact of life is that the median 401k balance of retirees between 55 and 65 is $95,600.  Many factors, but these 10% to 35% market corrections can throw a wrench into a retirement plan or at least delay it.  On average, 10 to 20% market corrections occur about every 1 to 2 years.  Larger corrections referred to as bear markets dropping 20 to 35% happen about once every four to seven years, and may not recover for 6 to 10 years!

These machetes hacking away large sums of cash from a portfolio are often horribly timed with respect to one’s retirement. The same poor timing might have delayed Warren Buffett’s growth had he not sold his initial GEICO position.

Any devastating market even can only be gracefully shrugged off if you’re sitting with significant cash enabling a buy the dip when it happens!  As was Buffett in 1976- on the repurchase of large sums of GEICO!

1.  DRY POWDER

So, one elephant in the room would be the millions or billions of dollars “dry powder” sitting ready to BUY when a correction happens. Warren Buffett has amassed such cash to capitalize on bargain low prices. The average investor sidelines a limited supply of cash to create the opportunity to buy on a crash.

These market corrections are great opportunity for those with DRY POWDER.

2. Continual Research

How closely do you keep your finger on the pulse of stocks you own. Even as a swing trader, Whooph doesn’t stare at the screen or research continually. So, the other elephant in the room is the requirement for continual research. 

Buffett maintains “hold forever” posture, unless fundamentals significantly change. I’m just guessing, you might not have a “research team” catering to your needs continually. Hence the need to sell at strategic points into the uptrend or rally. 

Whooph doesn’t even conduct scads of continual research. He watches or sets alerts for Disagreement between Price and Indicator in the chart. Technicians study effects -- market movements — of all causes or fundamentals. And believe me the market tips its hand.

The questions remains:

1. Can you tolerate massive losses periodically and still make a recommended 10x your salary retirement target?  

2. Do you keep significant cash DRY POWDER giving you the OPTION to buy on bargain lows on these corrections.

3. Finally, do you pay someone to stay abreast of fundamentals and news for each of your holdings or investments?

Then what CAN you do? 

Whooph says there are more ways than just fundamentals to achieve our goal of preserving your gains and capital. Fundamentals can form a basis for selling a poor performer, but fundamentals are a horrible timing mechanism.

As mentioned earlier:

Charlie Whooph operates whooph.Substack.com  where he shares:  TWO swing trades per week (FREE): Examples, How we use market structure, How-to consistently time swings to scale income. Daily since 1999. Charlie Whooph offers a FREE 5-Part Course teaching you how-to see and time a market swing. 

John Murphy, a seasoned trader who wrote the text which is used in preparation for the Globally recognized STA designation, Society of Technical Analysts, suggests that a Market “tells” or offers predictive signals for its weakness or waning momentum before swings or reversals, short term or long. He says:

Fundamentalists study the CAUSES of market moves.  

Technicians study the EFFECTS of all causes.

This insightful statement by John Murphy corroborates what Charlie Whooph has also concluded from 24 years of swing trading daily. That is, it may be unnecessary to do the continual company fundamentals research like that afforded by Berkshire Hathaway for our respected “hold forever” Warren Buffett.

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You must decide what you can tolerate. Periodically missing opportunities to buy low is a drag…on steady growth!  But it’s avoidable if a long term investor checks greed to lock in handsome profits, and so accumulates dry powder. The process of selling is a discipline. And I have two final pieces of advice.

Find a swing trader whose income is consistent. Learn his or her methods.

Warren Buffett is successful. Follow Berkshire Hathaway portfolio holdings.

Thank you for reading.

Sincerely — Charlie Whooph

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