Yesterday a real world situation occurred in a portfolio I’m trading this month with the profits going to a charity. The strategies in the portfolio were put together from the Swing Trading College class that is about ready to graduate (Swing Trading College Class 5).
One of the strategies the account is trading is an equities strategy that buys up-trending stocks after they have pulled back sharply and then pulled back even further on an intraday basis. The strategy has had strong historical test results and has been profitable in the testing every year from 1995-2008 (it’s a long stock strategy).
The stock I want you look at is ABG. The portfolio bought the stock last week at $8.95 when the signal triggered. Yesterday it opened higher and within 40 minutes the stock was trading at 10.30, 15% above where we bought it. The rules state to exit the position if the stock closes with an RSI reading above 70. At 10:10 am ET yesterday, with the 15% gain, the RSI was well above 70 and good profits were there.
Here’s the question I have for you.
1. Do you lock in your gains right there?
2. Do you start locking in gains by scaling out of the position at that time?
3. Do you follow the rules and wait until the close, risking giving back some, if not all of your profits?
Most traders will do number 1 or number 2. And you can’t blame them. It’s not every day that a stock rises 15% in a few days and gains can be locked into like this. Plus, it’s only 10:10 am ET. There still another 5 hours and 50 minutes of trading left in the day. Why put it at risk?
All good points. But the correct answer is number 3. Why? The rules and test results state that. They don’t state that if a stock is up 15% in a few days and its 10:10 am on a Monday, exit the position. The rules state exit at the close on an RSI reading above 70. That’s it. And the test results strongly support this; test results profitable in for 14 consecutive years. The correct answer is: You exit on the close.
If someone decided they really needed to lock in these gains and exit early, guess what happened? They left 5% of additional gains on the table. And when you start adding up all those 5% of additional gains left on the table, your results at the end of the year look very different than the test results and the results of the traders who traded it systematically. The strategy for those who got out early didn’t underperform. The person executing the strategy underperformed. They changed the rules, they grabbed the gains and the stock proceeded to rally to 10.86 where it was filled MOC.
Decide ahead of time how systematic you want to be and where discretion comes in. Spending days, weeks, months and years on testing and understanding markets is time well spent as long as you do the final and most important piece: correctly execute the trades.
Learning to trust your research and to trust your strategies goes a long way to making you a more successful trader. Yesterday’s trade in ABG is one of thousands of examples of proving this out.
Larry Connors is CEO and Founder of TradingMarkets.com and Connors Research.