When to Stop Trading a System

12/24/2014 6:00 am EST

Focus: STRATEGIES

Kevin Davey of KJ Trading Systems shares a question-and-answer between him and a relatively new trader about a trading system that he purchased. When it comes to these trading systems, for Kevin, the key is to believe in the system before you buy it. 

It is easy to know when to start following an advisor or trading system; start trading as soon as you have determined it is the right investment for you. But, do you know when you'll stop following that new system?

Whether you are following your own trading system, or following an advisory, newsletter, or some other service, if you don't have an exit plan for discontinuing it, you should.

Why? Studies have shown that when people are under stress, many times they make poor decisions. Certainly, if you were losing money with your systems you would be stressed. Consequently, you might make a knee jerk reaction to the losses, or you may stick your head in the sand and avoid a decision all together. Both scenarios can be dangerous. So, the time when you are losing is a bad time to determine when to exit.

Ideally, you already determined when to stop trading when you first decided to trade the system. If not, it is not too late. Just determine the metric(s) that are most important to you. They could include such things as:

  • Maximum drawdown
  • Consecutive losers in a row
  • Amount lost in a week/month/year
  • Overall profit after X months
  • Overall winning percentage dips below XX %
  • Significant break in your personal equity trendline, or equity moving average
  • New highs, or breaking of another "good" metric (yes, some people try to quit at the top)
  • Anything that can be measured and monitored

The exact condition you select probably is not as important as writing it down and sticking to it. That is the key. It needs to be solid, definitive, and written down. Ideally, you'll also tell your spouse or a friend, too, since it is harder to back out when you make the proclamation public.

I've heard that one money management firm's exit criteria is 1.5 times the maximum drawdown, and a 24 month commitment. Those aren't bad, but the best one is the one that you feel comfortable with, one you can stick with.

By Kevin Davey of KJ Trading Systems

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