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Trade Exits
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Because stock
trading is not
a game
Trade Exits Tharp's book, "Trade your way to financial freedom", puts much emphasis on trade exits and also position sizing. He thinks trade setups are the least important part of each trade, and he demonstrates a trading scheme where he enters a trade at random, and through proper position sizing and good trade exits, he shows that the scheme makes money. Sure, but I do think that a good trade setup will make you more money with a higher probability of success. There are many ways to exit a trade, and I want to highlight a few of them. One value of a stock that is nice to know is the ATR, the Average True Range. The True Range of a stock is the largest difference of : "today's high and today's low", "today's high and yesterday's close", and "today's low and yesterday's close". The Average True Range is the moving average of the True Range over so many days. It basically tells you how volatile the stock is, how much it can be expected to move each day. Setting an initial stop loss:  If
the price is moving up from a minor low, such as in many of the trade
setups I outlined, you set your first stop loss order below that minor
low, and set it about 0.5 to 1.0 times the ATR of the stock below that
minor low. Say the ATR of the stock in the picture is $0.65.
The minor low is around $22.50. Say you managed to
buy the
next day at the open at $23.22. Set a stop loss order
anywhere
from around $21.85 (1.0 * ATR below $22.50) to $22.18 (0.5 * ATR below
$22.50) depending on how tight you want your stop loss to be.
Using position
sizing in your
$50,000, max 1% loss per trade, account you would have bought 365
shares with a $21.85 stop loss, or 481 shares with a $22.18 stop loss.
The stop loss order can also become your trailing stop order
for
this trade, making the trailing stops either $1.04 or $1.37 below the
price. A trailing stop of at least 2 * ATR (up to 3 * ATR) is
recommended by many people, so $1.37 (2.11 * ATR) is great.Taking quick profits:  Some
people like to take quick profits, scalping small amounts. One way to
do that is to set a sell limit order for 1.0 or 1.5 times the ATR of
the stock above the buy price, for the above example at $23.87 (1.0 *
ATR above), or 24.20 (1.5 * ATR above). Let's follow the
stock
and see what happens. Bought at 1, at 2 the
stock reached $24.43, and you would have made quick profits if you had
set either sell limit.Letting profits ride: Other people let their profits ride. At 3 and 4, the stock price dipped to $23.22 and $23.25 respectively. Let's revisit the trailing stops, that you either placed at $1.04 or $1.37 below your buying price. They would have been adjusted at point 2 to $23.39 or $23.06. Notice how you would have been stopped out at 3 and 4 if you had chosen the tighter stop of 0.5 * ATR below the minor low, but you would still be in the stock with the less tight stop loss of 1.0 * ATR! A lesson to give your stop loss some room. Watch the Indicators: Look at how the indicators performed from 1 to 4. The Squeezed MA indicator dipped low several more times, indicating continued hesitation of the trend to commit strongly to one direction. Stochastics swung up and down around the 50 line, signaling as well an hesitation in choosing a strong trend direction. Price hovers above the 20MA, again indicating hesitation. Meanwhile the -DI(red) line of the MDI / ADX indicator showed continued loss of strength with the +DI (green) line staying strong above the zero line and the ADX (light blue) line rising steadily, all signaling a pending strong up trend!  See
what happened next:Bought at 1, survived lows at around 2 with a trailing stop of around 2 * ATR., soaring up to 3 with a nice 15% profit. The Squeezed MA indicator, stochastics, and price nicely above the 20MA are all committing to a strong up trend. The +DI keeps staying strong, while the -DI keeps losing strength, and the ADX line is reaching up to the top! All indicating a healthy up trend. Let those profits ride! |
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