This is how I like to exit trades
The market reaction to
the Fed’s change of rhetoric has been generally positive. The Dow and
S&P have advanced nicely since the announcement yesterday afternoon.
Unfortunately, the Nasdaq hasn’t confirmed this. Any move is suspect without the
Nasdaq. Still, the uptrend that began in mid-October remains in place. I’ll
continue to give it the benefit of the doubt and focus on the long side.
In
Monday’s column I began discussing profit taking. As a quick summary I
established that there is no profit taking system that would allow you to
consistently take profits at the very climax of a move. Therefore, profit-taking
techniques fall into two categories.
1) You sell too early.
2) You sell too late.
There are pros and cons to both methods, and I
discussed these in detail. The main gist of the conversation was that selling
too early made it easier to get fills, you can reinvest your capital quicker,
and your account is be less prone to large drawdowns. Methods that sell too
late, on the other hand, typically are less prone to shakeouts, and since they
give the trade more room to pull back, have much greater home run potential.
When traders begin to develop their profit taking
strategies, they need to choose a methodology that best fits their personality.
After weighing the pros and cons of each, traders need to make a decision as to
what mindset appeals to them more. For some people this is fairly cut and dry.
For many it is not so simple. Most traders are fully discouraged by the cons of
either method. They hate selling a stock only to see it go on to great gains
without them. They also hate giving back a large amount of their potential
profits and getting stopped out of a position long after it has topped.
Yet every trader must take profits. Otherwise you
won’t be a trader much longer. So how do you take profits without dwelling on
the negative aspects of it?
You need to find a happy medium.
Most of the trades I enter are entered because I
believe they have “home run†potential. Just a few really good trades can make a
huge difference in my profits. My goal is always to hold them as long as the
trend persists so that I don’t miss out on any huge gains. That means I want to
institute a “sell too late†philosophy.
Unfortunately, I was born with an itchy trigger
finger and voice in the back of my head that says, “Get out while the gettin’s
good! You’ve got a nice profit! Take it! You don’t want to see it slip away! How
much higher do you think this is going to move anyway?â€
By selling a portion too early I am able to quiet
this voice. Once I’m in a position where I have locked in a profit and perhaps
have a breakeven at worst trade, I find it much easier to manage the rest of my
position more loosely.
By understanding my own flaws I am able to design
a profit-taking methodology that fits my own personality. With profitable trades
I therefore have two basic goals:
1) I want to sell a part of the position too
early.
2) I want to sell the rest of the position too late.
By building these methods into my plan, the only
reason I would have to be upset about the timing of my profit taking decisions
is if I deviated. I want to sell the first part of the position before the
ultimate peak, and I want to sell the second part of the position after the
ultimate peak. If I hold the first part too long or get shaken out of the second
part too early, then I’ve managed the trade poorly.
There is no magic number for the percentage of
one’s trade to sell too early rather than too late. It’s a very personal thing.
Some people strive to make a high percentage of small profits. They like to see
their account consistently trend higher. They might be better served to take
most of the trade off too early, and save the rest to sell too late. Others may
prefer to take a small amount off early to get the trade in a better position
and keep a larger percentage to sell to late.
What’s important is:
1) You understand and accept the fact that part
of your profits will be taken too early.
2) You understand and accept the fact that the rest of your profits will be
taken too late.
3) You understand the pros and cons of both.
4) You choose a profit-taking strategy that you can live with. If your
personality clashes with your profit-taking methodology, you will have a very
difficult time adhering to it.
In an upcoming column I’ll discuss considerations
for adjusting your techniques based on the market environment.
Best of luck with your trading.
Rob
For those who may be looking to expand their
knowledge beyond just market timing, my
Hanna ETF Money Flow System utilizes the VIX in generating trading
signals for spread trades.
Rob Hanna is the principal of a money
management firm located in Massachusetts. He has spent the last several years
developing and refining methods for trading in stocks across multiple time
frames. He selects stocks using both fundamental and technical criteria, and
then trades them using technical analysis techniques.