EXITS

Anyone can get into a trade, it’s pretty easy. You just buy or sell anything at
any time for any reason and you are in a trade. However, in order to make
money you need to know when to get out. I could give the same trade to two traders, John and Harry, and Harry will be most likely to make money
on that trade because he knows how to plan an exit. Even if he loses on it,
he will probably get out with a smaller loss and restrict his damage. This,
in my eyes, is long-term winning.

I’m not going to spend too much time writing about exiting now as I’ll
delve into it later in the book, but I’ll go over the basics of it to give you an
idea of what goes into the trading plan. First of all, you will want a signal
that will get you out with a profit. This signal can also get you out with a
loss even though it isn’t meant to act as a stop. You can see how this may
happen in Figure 5.3. Here, I’m using a simple moving average crossover
system that only takes trades in the direction of the major trend. It buys
at the close of the day when the faster moving average line crosses over
the slower one. I got a buy signal at the circle E1 and sold it at circle X1
for a great trade. The next trade happened at circle E2 when the averages
crossed again. I would have placed a stop just below the lows of the previous
move indicated by stop line S1. Now, even though the market had not
reached the stop line at the time, the trade was liquated because I got an
exit signal telling me the reason I entered the trade has changed.
After the exit signal you will need a stop signal to give you a safety net.
Stops are complicated, because of the many ways you can use them; again,

FIGURE 5.3 Daily Dow Jones
Source: © TradeStation Technologies 1999. All rights reserved.


more on them later in the book. But overall they are just there to protect
you. One thing to keep in mind is that your loss target should always be
less than your profit target. If you are risking three points to make two
points then you are making a poor trade. When I trade, I look at my exit
before my entry and determine the risk involved and the potential earnings
I can make. If the ratio is good then I start looking for an entry. If you are
writing a system, look for this in your back testing. Is the proper place to
put a stop versus the amount you can make reasonable? If not your system
won’t work. Knowing where to place stops will make you a winning trader
on its own, so don’t ignore them like many traders do. Even in the previous
example where I do not have a set profit target, I know that in an uptrend
the market has potential to move up 5 to 10 times what I was risking with
my stop on a good trade. This is the start of a winning formula, you just
need to be right enough times to make it tradable.

One other note, some systems will always keep you in the market.
These don’t use stops but use the exit signals to not only get you out of
the market but to get you in the other way. The theory behind these is if I
don’t want to be long I should be short. These strategies are normally used
by overtraders, who always have to be in something and need the action.
Even if you have this type of system, I recommend using an emergency stop
to protect you should the system fail to give you a signal quickly enough if
you are losing big on a trade. If you go back to the chart in Figure 5.3 and
remove the rule of only taking trades in the direction of the major trend,
you have a system that is always in the market. Instead of getting out at
point X1, you would be exiting and getting short at the same time.