Simple and Logical Trade Exits

by Vincent Richman

Most traders and investors have no trouble deciding when to get into a position, but a majority of novices, and even those with far more experience, falter when asked to describe how they decide when to convert back to cash. There are few aspects of trading or investing more important than a clear method for determining when to end a trade or cash out of an investment, either with a trading profit or a trading loss.

First, let's define a couple of terms: For purposes of this discussion, a trade is any position, long or short, intended to be held for anywhere from minutes to weeks. An investment is a position, either long or short, that is expected to be held for months to years.






Most investors and traders use either fundamental factors or technical indicators to determine when and where to enter a position. Anyone who doesn't use one or both of these general approaches is probably neither a trader nor an investor, but just simply a gambler. The entry criteria of most high-quality fundamental and technical approaches are derived from significant research into what works and what doesn't. Unfortunately, the research is usually much more thorough on how to get in than on when to get out.

It is unlikely that you would undertake a home remodeling job without a clear idea of what you wanted to have when you were finished. You are also unlikely to begin a trip without some idea of where you want to end up. Why is it then that it is so easy to enter a new position with only a vague idea of what criteria, if met, clearly say it is time to go to cash?

Many "gurus" of trading and investing have said to "Cut your losses and let your profits ride," but that is almost as obvious and inane as saying "Buy low and sell high." So, how do you decide when and where to get out? Here are some rules to follow. They work.

When you enter a positon, immediately write down your expectation of events (in the case of a fundamental approach) or patterns (in the case of a technical approach) that will represent a change in the circumstances that led you to take the position. Also note down the total time you are willing to allow for things to happen. If the events or patterns have not ocurred within the time you determine in advance to be reasonable at the entry point, then go to cash. If the events/patterns occur go to cash no matter where the price has gone. Do not worry about what happens to the price afterward.

Your timeframe will determine the magnitude of profit that is reasonable to expect. A long timeframe logically can yield a greater profit than a short timeframe. However, a trader with a short timeframe can be just as successful in relation to his initial objectives as an investor with a long timeframe.

Let's look at a real example for illustration. A trader who bought Microsoft (MSFT) the week of October 27, 1997 would have paid about $130 per share. That trader could have sold his position the week of December 1 for at least $143 per share for a nonleveraged profit of 10% in only five weeks - an annualized profit of approximately 100% not counting the very important negative impact of commissions and slippage. An investor who bought at $143 per share that same week would have endured a drop to $122 over the next three weeks, but if the investment were held for at least a year, he could have sold at a split-adjusted price of $268 per share, or 87% profit in one year, slightly less on an annualized basis than the trader, but better after adjustment for lower commissions (fewer trades) and long-term capital gains tax treatment.

NEVER, EVER allow yourself to change your planned timeframe or event/pattern exit criteria after you initiate a position. Doing so in the hope of capturing an early profit or in the hope that a losing trade will redeem itself by holding out a little longer may improve your single-trade profit from time to time, but will inevitably lead to chronic violation of your own trading rules and will prove to be a short-cut to failure. Make a plan and stick with it. If your research is good and you trade with discipline, you will succeed.

For more information on trading and investments visit http://www.tradingprofitsmadesimple.com today.


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About the author:
Vincent Richman has traded in various markets for over three decades.






Published at Aug, 24 '06 , Read 839 times.

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