To Exit or Not Exit a Trade

02/13/2013 6:00 am EST

Focus: STRATEGIES

Michael Bellafiore

Author, One Good Trade: Inside the Highly Competitive World of Proprietary Trading

New traders are often advised to be patient, but is there such a thing as being too patient? Here, Mike Bellafiore of SMB Capital discusses what to do when a stock does not move in the direction of your position as expected.

Hi Mike, I know you are a busy guy but I had a question regarding exiting potentially wrong trades ahead of my stop point, something I’ve had difficulty with in the past.

For background, I have stopped this practice as I have found that acting on my newbie instincts or interpretations of order flow has led me to cut positions that were still abiding by my reason to enter, and later followed through, leading me to have to re-enter on a later opportunity or not at all.

In Green Mountain Coffee Roasters (GMCR) on Friday, I saw one of my favorite setups evolving and eagerly entered. It had a nice downward move in the morning and was consolidating above 45. It eventually dropped through 45 on strong volume and retraced back to the level. Support from yesterday looked to be 44, so the risk/reward was good. I got short one lot on the retracement back to 45. When it only briefly tested 45 and rejected the level pretty quickly, and began to move away, I added another lot for my typical core of two lots. Then it got to 80c and couldn’t seem to get the selling pressure to continue downward. The offers stepped up fairly readily back to the whole, where it started to hold more tightly below the level.

Upon review, I had the thought that it might have been prudent to cover half when it appeared to make a higher low at 80c (I thought about it at the time as well), and certainly when it tight below the level, unable to hit the bids below 95c. However, I followed my rule and waited for it to lift and stop me out.

Might you have any wisdom, given my experience level (less than two months live), whether it is prudent to exit trades that are not following through, yet still have a valid premise that has not been violated yet?

… as an aside, my deepest gratitude for all the work and information you present to the public. I have looked all over for information on my trading style and intraday trading in general, and it’s so full of negativity, snake-oil indicator miracle systems, etc. I have a great deal of respect for SMB and have put a lot of you and Steve’s information and techniques to work (compiling a playbook one day/entry at a time has been the most helpful). If I can continue my mild profitability I hope to invest in, at the least, your Reading the Tape course.

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First there is so much right in your review.

  1. You are in a great stock.

  2. I love how you are adding to a position that is working.

  3. I love how you are thinking about your trading and working on your game.

  4. I love how you are taking the time to improve and accept mentoring feedback.

Well, you might not know you are asking this, but you are. Your question is: Is it OK to add a time stop to my trading strategy? Said another way, if a stock does not move in the direction of my position as I had expected, is that a valid reason to exit. The answer to that is yes. Let me offer you a trader thought structure to allow you to answer your own question, which I discuss in my next book, The PlayBook.

First, determine if you are in a Move2Move trade or a Trade2Hold. I see this as a Trade2Hold, so let’s just skip to this. For a Trade2Hold, we stay in the position until there is a Reason2Cover. The trader crafts rules for his Reasons2Cover.

Is a time stop a Reason2Cover? It is. If you do not like the way the stock is behaving, if you thought it ought to have gone down further and faster and it hasn’t, then this can be a Reason2Cover. It is up to you as to how you craft your rules. You could very well have written rules to hold this position. There really is no right answer. There is work that you must do in crafting your rules for how you want to trade this position.

After you craft your rules to manage this position, do not obsess about the result. If you exit and the stock plummets, then no matter. You followed your rules. Your job is to do the right thing and control your risk. It is not to be right.

Since you asked me, I would hold this position. I like this setup too much to miss a potential big move with real size. My rules would not allow for a cover, or a time stop, with this setup. But that is just me.

By Mike Bellafiore, Co-Founder, SMB Capital

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