Professional traders follow several general rules when they buy, sell, and hold investments. Consider your own rules of thumb when you set your own investment strategy.
Consider setting stop or limit orders to try to maximize profits or reduce losses
Factor in a company’s fundamentals when you consider buying its stock
Investors just starting out are often excited about getting into the market. But before doing so, it’s important to understand factors that can influence decisions on when to buy, sell, and hold on to stocks to max growth and limit losses.
There’s no way to know exactly what a stock or asset will do for sure, because its price can be impacted by many factors, from broader market conditions to its own business performance. While there’s no one specific strategy that’s the best for everyone, professional traders do have several “rules of thumb” that they follow when they consider their investment moves, such establishing entry and exit points and assessing fundamental factors.
Individual traders can develop their own way of buying and selling after learning more about these general principles.
An entry point is the price level where you buy or “enter” an investment, and an exit point is the price where an investor sells or “exits” the investment. Ideally, you want to determine your entry and exit points in advance to provide clear a strategy toward minimizing risk and maximizing returns. Establishing entry and exit points will also avoid making decisions based on emotion.
Investors try to establish an entry point to try to maximize gains. While some are very long term buy and hold investors, many other think it’s also important to determine when to cut your losses when a stock’s value is declining. Many traders may find that it feels natural to hold on to underperforming assets and wait for their value to rebound, but this can be a mistake if the asset continues to decline. While some professional investors do adhere to a buy and hold strategy, many professional traders set a clear plan for buying and selling.
Traders commonly use stop and limit orders to help maximize gains and minimize losses. Instead of constantly monitoring the price movements of your investments, you can establish stop or limit orders so that you can enter or exit according to your plan. A limit or stop order dictates how much stock to buy at a certain price or once it reaches a certain price. So, you can set a limit or stop order for higher or lower than the current market value to try to time your trades in a way that minimizes your losses or maximizes your gains. Market value is the current price of the stock.
Stop and limit orders work differently but relate to trader behavior in the same way in that they allow investors to not have to constantly monitor price movements, but investors have different goals with each. With limit orders, a trader’s goal is to buy or sell a security at a particular price. For example, if a stock’s market value was $65, a trader who wants to buy it may set a buy limit order at $60 if that was their ideal entry point. Similarly, if a trader wants to sell that stock, they may set a sell limit order of $70 if that was their planned exit point.
Stop orders are generally used more as a defensive strategy to minimize losses. To avoid missing out on a potential opportunity if the stock continues rising in value, the trader may set a stop order at a point well below the current price. But if that stock is expected to be trading lower, the investors may want to try to minimize their losses with “tighter” stop order that might be close to the current price of just below the current price.
Stop and limit orders are designed to trigger when the trader’s pre-designated price is reached. So in the case of the trader setting a $70 sell limit order, the stock would sell automatically when the stock rises and $70 is reached. Or if there’s a stop order under the current price, the stock would automatically be sold once the price falls and it hits that price. In our sell example, the investor with the limit order wants to sell when the price goes up, the investor with the stop order wants to sell when the price goes down. That is the key difference between a limit and a stop. Certainly if a stock is at 50 and one investor places an order to sell “if” it goes to 60 and another investor places an order to sell “if” it goes to 40 those investors are of two very different minds. But that’s not the only difference.
There are risks to limit orders. For one thing, a limit order “guarantees the limit price or better” but on the down side, it might never get filled. With a stop order, usually intended to exit a stock position if the price falls, once the stock in question hits the stop you’ve set, your stop order becomes a market order, where it competes with everyone else’s to get filled. There’s no guarantee you’ll have your order filled at the exact price you’ve set. If you set a stop order to sell at a certain level, you might actually end up selling the stock slightly or in some cases dramatically below that level.
Another risk of stop orders is that their automatic “bail out” feature can be good news or bad news. If an investor has a sell stop at 60 and the price falls to 35, then stopping out, even if the 60 “triggered” stop fills at a lower price, looks like a good thing. But things could turn out differently. For instance, if you bought a stock at $65 and set a stop at $60, the stock might go down to $59 and be sold, and then jump back to $70.
As you consider when to buy, sell, and hold stocks, you most likely want to learn about the financial strength of a company, as many fundamental analysts do. One way to do that is through the company’s financial statements like its quarterly statements, which it’s required to file with the Securities and Exchange Commission (SEC). This financial information is available both on the SEC’s website and usually on the “investor relations” page of the company’s website.
Financial statements have a wealth of information. To simplify your review, you can focus on several key figures, such as the company’s revenue or sales and how it compares to its past performance. Are the company’s sales increasing or decreasing? If sales are rising, is that growth slowing or gaining momentum? Look at the company’s guidance for revenue or sales, which reveals how it expects to perform in the future.
Cash flow can tell you something about a company’s liquidity. Many professional traders consider it the foundation of a company’s financial health and factor it into their decision on whether a particular stock might be a good investment. If more money is coming into a company than the company is paying out, then it has a positive cash flow, which is generally a good sign. However, if the company is paying out more money than it’s receiving, then it has a negative cash flow. If a company’s cash flow is increasingly negative, that could be a red flag.
Potential investors might also want to familiarize themselves with a company’s earnings per share, gross margins, or any dividends and share buyback programs before deciding whether to buy a stock.
Technical analysis is often used by traders to evaluate an asset’s past price trends and patterns shown on charts, as a rule of thumb for buy, sell, and hold decisions.
Technical analysts generally believe broader economic factors have already been factored into a share’s market price, whereas other traders may rely more heavily on looking at fundamentals like information in statements. Instead of scrutinizing outside influences and financial statements, technical analysts take a more visual approach, to looking at patterns in trading to anticipate future stock movements to determine the best time to buy or sell.
Chart Patterns are a key part of technical analysis. A chart can provide an at-a-glance summary of historical prices, including highs and lows, that can reveal trends. Professionals use different chart patterns in different ways such as looking for trend lines over a certain time period.
Technical analysts may also look at indicators like trading volume and moving averages for clues as to when to buy, sell, or hold. Trading volume is the amount of shares being traded. When trading volumes are higher, some traders say that indicates stronger momentum behind the stock’s movement.
Moving averages, such as a 50-day moving average or a 200-day moving average, smooth out price changes by averaging prices of a given time frame. So, a 50-day moving average would average the closing prices of the previous 50 days. With these numbers, you can see moving average trends as you do price trends. When the moving average has been rising, the stock is in an uptrend, and when the moving average has been declining, it’s in a downtrend. Keep in mind, trends on charts, even those that have been in place for a long time, are still a backward looking view, as a trend can change at any time.
Investors have a lot to consider in buying and selling stocks, but professional traders rely on several key pieces of information when they make their decisions. New investors can get started by slowly building their knowledge and developing an investing strategy that considers their goals. Learning about a company’s earnings reports and price trends can be a good first step in determining whether an asset would fit with your investment goals.
Ultimately, it’s up to each investor to determine which strategy and which investments are in their best interest based on factors like their time horizons and risk tolerance.
Do Not Sell or Share My Personal Information
Content intended for educational/informational purposes only. Not investment advice, or a recommendation of any security, strategy, or account type.
Be sure to understand all risks involved with each strategy, including commission costs, before attempting to place any trade. Clients must consider all relevant risk factors, including their own personal financial situations, before trading.
A trailing stop or stop loss order will not guarantee an execution at or near the activation price. Once activated, they compete with other incoming market orders.
Market volatility, volume, and system availability may delay account access and trade executions.
Past performance of a security or strategy does not guarantee future results or success.
Options are not suitable for all investors as the special risks inherent to options trading may expose investors to potentially rapid and substantial losses. Options trading subject to TD Ameritrade review and approval. Please read Characteristics and Risks of Standardized Options before investing in options.
Supporting documentation for any claims, comparisons, statistics, or other technical data will be supplied upon request.
This is not an offer or solicitation in any jurisdiction where we are not authorized to do business or where such offer or solicitation would be contrary to the local laws and regulations of that jurisdiction, including, but not limited to persons residing in Australia, Canada, Hong Kong, Japan, Saudi Arabia, Singapore, UK, and the countries of the European Union.
TD Ameritrade, Inc., member FINRA/SIPC, a subsidiary of The Charles Schwab Corporation. TD Ameritrade is a trademark jointly owned by TD Ameritrade IP Company, Inc. and The Toronto-Dominion Bank. © 2023 Charles Schwab & Co. Inc. All rights reserved.