/ Trading

Exit strategies and (lack of) emotional control

When traders start looking for that magic “bucket load of cash” trading system, often the last thing thought about are exit strategies. Yet it is the exit that make a trader money.

The first thing thought of in a trading system is entries. Yet we forget that you make bugger all money if you can’t exit with as much care as you entered.

The basic scenarios when needing your exit strategies

There are three basic scenarios that a trader will find themselves in when thinking of their exit:

  1. A trade has moved as expected and they are in profit
  2. A trade has moved opposite to what they expected, and they are in loss
  3. A trade is dancing around the neutral zone of their trade

At first glance, you would think the easiest exit scenario is when you are in profit. After all you are “cashing in” so how hard can it be?

… exits are where the money is

In reality all three can be as hard as each other. The reason?, like most things with trading, is emotion.

Here are my personal underlying emotions that might stop you closing a trade under these three scenarios:

  • A trade has moved as expected and they are in profit (GREED)
  • A trade has moved opposite to what they expected, and they are in loss (OPTIMISM)
  • A trade and dancing around the neutral zone of the trade (FEAR)

Let’s look at them one by one.

Cannot close a profitable trade (Greed)

Everyone fights greed every day in their life, always “wanting” rather than sticking to what you “need”. It is part of a materialistic modern day culture that most of us are subject to.

Trading is no different, and it is usually greed that can turn a nice logical, well planned and profitable trade into a losing one.

When this happens, a trader reacts two ways.

  1. They are filthy with themselves for letting it all get away.
  2. They tell themselves “well I was right with my prediction, the market just had it in for me”.

Think of this; you plan a trade, track the set-up like a hawk, wait for the exact time to enter a trade, calculate your stop, and you are in the trade.

The price action moves like a gazelle towards your scantily thought about target (if you set one).

… while you wait the week out for the price to turn you have tied up your entire margin, locking yourself out even more profitable trades

The sense of delight sends your brain into overdrive, working out the profits, imagining the Ferrari soon to be in the drive-way, wondering if anyone has done 2000 pips in a day.

This is when you know you are in some trouble, this is when greed has started to set in. Now you are removing your profit target to “see how far this goes”. You don’t move your stop loss, because you don’t even contemplate that it might reverse, and you are “on for the ride”, all the while with no idea on your possible exit strategies.

A common saying is “cut your losses, and let your profits run”. But, how do you ride your profits, without risking a reversal that you will put down to “a correction that will soon move back my way”?

One way is to move your stop loss to break even or better as soon as it is possible without increasing the risk of being whipsawed. That will ensure you will not lose money on the trade, ease your stress levels, and bring world peace.

I take the view of never let a winning trade turn into a losing one so at least lock in 1 pip if it makes you feel better.

If the move was stronger that you anticipated, and you had a 20 pip mental profit target, see of you can move your stop loss to as close to the original profit target as possible.

What you are doing there is locking is close to your original risk/reward while opening up the possibility of catching those occasional runners.

You can use one of the many trailing stop techniques or an indicator like the parabolic SAR indicator to follow the trade after that.

Cannot close a losing trade (Optimism)

I was going to use the word "delusion" for this one but felt perhaps that is a little harsh. You know the deal; you enter a trade, you set a 25 pip stop loss, the trade moves the wrong way and you are at -20 in a flash.

You look at the chart again in a panic and think “Of course! I should have set the stop loss beyond that resistance level from the year 1967, what was I thinking?”.

Now your stop loss is -35, and your risk percentages are out the window.

Now the price continues to move in the wrong direction. You either cop a -35 pip loss instead of -20, or you remove your stop loss all together in blind faith the trade will come back.

…you make bugger all money if you can’t exit with as much care as you entered

Some may say, that they removed their stop loss and their -100 pips turned into +10, so there .. stick that up your jumper. I had those trades to, just before my 2nd, 3rd and 4th blown account. Ah those were the days.

Remember while you wait the week out for the price to turn you have tied up your entire margin, locking yourself out even more profitable trades.

The advice on this is simple. Never move a stop loss further away from your entry. Plan your trade and trade your plan.

You want to close a trade dancing around the neutral zone (Fear)

This one is different, this is when you have a trade floating around your entry point, what do you do?

Do you take a small gain “just in case” it turns?

I say never close a trade around the neutral zone. The aim of all traders, is to see and act on movement before the majority of others. If you are in early, when the others have caught up, you can let them make you money.

Don’t be fearful of a losing trade, instead trust what you saw when you placed the trade. There will be times when your trade doesn’t work out, but when you are right and in early, these are the trades that feed the family.

To summarise:

  • Always assess your potential profit target, and close, or lock it in as soon as possible with your stop loss.
  • Never move a stop loss away from your entry price.
  • Don’t be fearful you could be wrong, instead be trusting in that you are probably right.

There is so much more to exit strategies that the above, but it is important to get the foundations right.

After that you can move to no-stop methods such as those taught by Rob Booker and others, or more advance exit strategies such as those you can find in Alexander Elder’s book Entries and Exits.

Just remember, exits are where the money is.