Importance of Exiting the Trades PROPERLY

Discussion in 'Trading' started by Spectra, Jan 11, 2007.

Article useful to newbies?

Poll closed Jan 21, 2007.
  1. Yes, very!

    3 vote(s)
  2. Some what

    2 vote(s)
  3. A tad bit

    1 vote(s)
  1. Without knowing a trader’s particular situation it is difficult to give particular advice.

    The first objective is not to duplicate our results or anyone else’s results. Your first objective is to be able to put on ALL the trades that your system signals call.

    This means that 100% of the trades your method signaled should have been put on, not 50 or 80%. If a trader can accomplish that feat during the first month of trading that trader should be congratulated.

    Our studies and my real life experience have proven that most newbies have no problem pulling the trigger on a trade. At the beginning of a trade, especially if a trader is following a new method or strategy, optimism runs high---you “absolutely know” the markets are going to behave just as those perfect examples from that best selling trading book, How I Made More Money than Donald Trump Last Year Day Trading at Home in My Underwear, or at that packed Las Vegas seminar.

    Managing a trade after the entry along with money management are the topics least discussed by advisors yet I have found that most successful traders consider those two elements more important than what the moving averages, stochastics, or market profile is doing.

    The two parts of managing a trade are the stop and the profit targets. Although a few setups might not have a built in stop at least during the same trading day (the Gap Trade comes to mind) the other trading calls do have a stop that should be placed immediately upon entry. The stop that we initially put on is what I prefer to call a catastrophe stop, meaning a place where I want to get out if the price moves against my position immediately, beyond normally expected adverseness as defined by the recent price volatility. The big mistake that new traders make is to assume that this stop is some kind of “universal law” stop and one not to meddle with. This is a misconception. Most professionals are quick to reduce risk, and moving a stop closer is one way to reduce risk.

    The other way to reduce risk is to reduce the number of contracts traded. This can be accomplished by taking some profits at initial profit targets. The true goal that every trader should attempt to achieve is to get as quickly as possible to an active trade in a risk free situation. Let me give an example. Suppose we put on a scalp day trade long at 12260 with a stop at 12250. We buy 10 contracts. Our initial risk is actually 100 points (10 x 10). Assume the market moves up only 5 points to 12265. By not changing your stop you have actually increased the risk of adverseness by 50%. Your stop at 12250 is 15 points away multiplied by the 10 contracts is a risk totaling 150 points. The professional actually abhors too much risk. What if you take off 5 contracts at 12265? Now even if you keep the original stop you are only risking 50 points (5 contracts x 10 points). But wait! You have already earned 25 points to pay toward that risk (5 contracts at a 5 point profit). Pretty good deal. To complete our probability magic let’s say you now move the stop up 5 points to 12255. You have now reduced the risk on the trade to about 0.

    On the other hand you still have a partial position on. If the market moves more favorably in your direction you can now participate. But the real benefit and probably the most important is the psychological zone you have put yourself in. You have put the odds greatly on your side to being a winner. Not only a winner who has closed out a position, but the feeling a true winner undergoes during a trade. You are enjoying the feeling of not having an emotional stake in the trade. If it continues in your direction you make more money; if it reverses it can’t hurt you.

    So even if the method does not place a revised catastrophe stop, you should begin the practice of moving your stop closer and reducing risk. If the method calls to take partial profits or half profits you should already be thinking of reducing risk. Take those profits at the market. Even a poor fill has some good benefits. Start moving that stop.

    I have received lots of questions regarding traders who do take partial profits at our first target, then sadly ride the remaining position all the way down to the original catastrophe stop. You must remember that this is an initial catastrophe stop. If you have been fortunate to at least take some profits then that is good, not a catastrophe. Think about this; even if you took 5 contracts off at a 5 point profit and moved your stop on the balance of your contracts to 12260 then the worst case scenario is that you have made a total of 25 points on that scalp trade. You still netted $75.00 on a “go nowhere” trade.

    I don’t know about you but in the first 3 years of my trading, losing thousands of dollars, I would have been very happy to substitute what I did for only that kind of "go nowhere" trade. That is $18,750 per year on let’s say $50,000 margin or 37% on your money.

    So how do you move stops? There are a number of popular ways. One way is to use the low of the last 3 bars on the time frame you are trading, let’s say a 5 minute chart. Most software packages have a version of Welles Wilder’s parabolic stop system. True this was mostly designed to keep traders in a longer term trend, but at least it starts to close the distance between the initial entry and original stop. Another technique is to move the stop by an increment of the favorable market movement. If the market moves 6 points in your favor you might move the stop up by 1.3 times that favorable increase or 7.8 points (round it up to 8 ).

    We have used a stop method that is volatility, time and volume based that moves closer faster as the market moves faster in our direction and slower if the market is moving slower. It also begins to bring the exit closer as time moves on with a lack of additional favorable movement. We are working on programing the eSignal and TS script to offer it to others in the future. It is not the holy grail but it certainly beats giving back lots of hard won profits for fear of making a decision.

    Finally I would like to add that some traders insist upon sticking with our initial targets when we first enter a trade. Please remember that markets are dynamic and what may have looked like a great trade 3 minutes ago begins to look iffy as new orders enter the market. Obviously if the market moves against us in a minute and takes out our stops, all of us will be stopped out


    Alex L. Wasilewski
    Co-Founder & Head Trader
    Trades That Work
  2. Tcbjx9


    good points.. thx