Maximize your profit by making a larger number of small buys and sells

One of the rules-of-thumb in investing is to minimize how many trades you make as too much trading can reduce your returns. Today, we will discuss how to flip that rule-of-thumb and maximize your profit by making a larger number of small trades.

Transact through zero-cost limit trades

In the past, when investing in assets such as stocks, investors had to pay steep commissions. For example, when I first started investing, the cheapest trades you could make had a $19.99 transaction cost. That meant that any investment you made automatically started off as a loss because you had to pay these transaction costs both when you bought and when you sold. Imagine if you only had $100 to invest. When you bought a stock with all of your money, you only got $80 worth of that stock (technically it’s $80.01, but I’m rounding numbers for this example) after your commission. That stock would need to grow to $120 in value or a large 50% increase in order for you to just break even, because you also had to pay the commission when you sold. These commissions are an example of transaction costs. Transaction costs are one of the major reasons that frequent trading leads to lower portfolio returns. The more you trade, the more of your money leaks away in transaction costs.

Nowadays, most brokerages offer zero-cost trades. In actuality, there is no such thing as “zero-cost” in this world. There are a number of ways that brokerages recoup the lost income from charging you nothing for a transaction, such as higher bid/ask spreads. However, if you use limit orders, those shouldn’t really impact you. So, as long as you transact using zero-cost limit trades, you don’t have to worry about transaction costs.

Keep your emotions out of investing

The second reason why frequent trading hurts returns is making emotional trades. There are very few things in this world which are more powerful drivers of human behavior than emotions such as greed or fear. It’s typical for people to get greedy when an investment is doing well and purchase a lot more than they should. This is the opposite of the “buy low” mindset that you need to cultivate. Conversely, people who are afraid when their investments are going down in value panic and sell far more than they should. This is the opposite of “sell high”. Getting caught up emotionally in your investing leads to far more trading in the exact opposite direction of what you should be doing, which reduces your profit.

Using limit orders is a way to prevent yourself from getting caught up with emotionally-driven trades. A limit order is an order that you place which triggers only when a security’s price hits a predetermined number (the limit). For example, you can set a limit order to buy a stock at price X. The order only triggers when the stock’s price is at or below X. Likewise, a limit order to sell a security only triggers when the price of that security is equal to or above the limit price. If the security never reaches your price target, the order does not trigger.

The way to use limit trades in a manner that improves your profit is to ladder those trades starting at your price target. This does require you to have price targets for both buy and sell levels. You should have the discipline for any investment that you make to establish price targets for either purchasing them or selling them. Use the valuation methods I outlined in my article on how to buy low and sell high to help you determine those targets.

Once you have your target prices, set multiple small trades around those prices. For example, for a buy transaction, set limit orders starting with your target buy price and going lower. As an illustration, if your target for a stock is $10, set limit orders at $10.00, $9.80 and $9.60. Stock prices have a lot of variability in them as everyone has their own valuations and also trade with their emotions so there is meaninful chance that multiple of your limits will be triggered. By setting laddered trades, you can take advantage of that variability to get either lower prices when you buy or higher prices when you sell. To even further improve your average pricing, set limit orders with higher volumes at the more advantageous prices. In the example above, set your limit orders to buy 10 shares at $10.00, 11 shares at $9.80 and 12 shares at $9.60. If all three limit orders trigger, your weighted average cost will be closer to $9.60 than $10.00. Now, not all of your limit orders will trigger. That’s okay as the worst you’ll have done is to have made a transaction at your target price. There will always be other opportunities for profitable transactions. By setting limit orders in the manner above that ladders starting at your target price, you take away the emotions that lead to over frequent trading in the wrong direction.

This completes today’s post on maximizing your profit by making multiple smaller trades. The practical steps you can start taking from today’s post are:

• Determine the buy or sell prices you are targeting for your investments: for any investment you have made or are planning to make, you should have target prices for buying (buy low) and selling them (sell high)
• Set up laddered buy or sell limit orders: Get buy or sell orders in place as the investment’s price approaches your target. Use limit orders and have multiple orders in place starting at your target price to take the emotion out of your transactions
• Set limit orders to maximize your profit: Increase the number of shares you sell at each successive higher price for sales or at lower prices for purchases. This way, you weight your average transaction price to maximize your profit

Thank you again for joining me on my journey to build financial literacy for young adults and their families. If you are interested in reading more of my posts, please access my author page (https://shopping-feedback.today/authors/sudhir-sahay) where you can see all the posts I’ve published. If you have any questions on today’s post of if there are any topics you’re interested in my broaching in future posts, please let me know. I can be reached at [email protected].