After many years of trading for my living, and even though I know
better, and even though it bugs me, I sometimes still exit positions too
late. It is really hard to be a successful trader without cutting
losses. The old adage states: "the first loss is the best loss." There
is a great deal of truth to that. One of the hardest things for the
investor to overcome is the "it's coming back" mentality. I suspect that
traders have a tendency to stay in a position too long because most of
us have been taught that investing is best done with the buy and hold
approach. Many of us, particularly those who've been involved in
athletics, have also been taught not to give up until the bitter end.
In my view, that advice is simply inappropriate for profitable trading.
We are much better off if we establish an exit strategy before we ever
enter a position. That exit strategy can be anything from the break of
a trend line to a specific percentage loss to a break of a price support
or resistance.
If we do establish an exit before ever entering a position, I suspect we
are more likely to adhere to the exit strategy we have chosen. That is
particularly true if we put a stop loss order or a trailing stop or a
contingent stop in place right after we enter the position. Having
placed some sort of protective order, we at least would have to take
some action to undo previously established exit strategy. Hopefully, at
least, having to take the action would make us think twice before
undoing the positive step we have already taken. Alerts may also be
helpful, but in watching many traders over the years, I have found that
they are less likely to pay attention to their own alerts then they are
to leave a stop in place.
When a position moves against us, there is a terrible temptation to let
it go a little farther in the hope that it will turn back in our
direction. More often than not, it seems, that the hope is
unfulfilled. When we set a specific exit, it is generally at a specific
price. When that exit is violated by even a penny or two, it is,
nonetheless, violated. Yes, acting on our preestablished exit strategy
when a position has gone through our exit point by only a penny or two
may result in being whipsawed at least occasionally. I have found that
it is better to suffer the whipsaws than it is to watch the damage
compound itself as the position moves steadily against us.
Though less and less frequently as I gain more and more experience, I do
fail on occasion to adhere to my own preestablished exit strategies.
However, I find that I now actually enjoy pulling the plug quickly on a
position that has moved against me. I know this action almost
always results in a loss, but it is so much better than hanging on and
watching the loss mushroom.
The opposite side of the coin is also true. While it is critically
important to cut losses, it is equally important to let profits run.
Any exit strategy we employ should incorporate not only a loss cut, but
also a method by which we remain in a position that is moving in our
direction. Some ways to attempt to accomplish both the loss cut and
letting profits run would be to regularly move a stop in the direction
of the position, or or to utilize a percentage trailing stop loss
order. Another simple device is to simply make a trend line the exit.
If we are in a bearish play, for example, and the stock breaks up
through the downtrend line, that would be time to exit. Unless and
until that trend is broken, we would stay in that position. On the
other hand, if the position we enter is bullish, we could make our exit
a downward violation of the uptrend line.
In my estimation any of the devices about which I've written are better
than using our "feelings" about a position as our exit methodology.
Good Trading!
Bill Kraft
Mr. Kraft's past articles are posted on our website for your review.
-- by the Dividend Investor Team
