Take Profits or Let Them Run?

05/31/2011 9:15 am EST

Focus: STRATEGIES

A trader tries to tackle the age-old question and imparts some advice on when to stick with an open position and when it may be prudent to back out early.

All of us have the occasional urge to jump ship early from a trade, but when is it the right time and how should that be done?

You want to stay in long enough to make as much profit as possible without letting your position start to go the other way and give up those hard-earned points.

Let’s take a look at a conversation I recently had with a trader I was helping:

Hey Jeff,

I’m long ***, as it just looked like a nice set-up. I went long four days ago, but it is behaving horribly. Currently, I don’t see any pattern and would not make this trade now, but it is only half way to my stop loss. I am unsure what to do. How do you approach trades you aren’t convinced of anymore, but have not been stopped out of?

Also, one of the mantras I read often is “cut losses short, let winners ride.” I am wondering how to interpret this “cut losses?” I find myself thinking, “I am not convinced in this trade anymore, but maybe it will turn around; it’s just half a position left to lose.” When my analysis of the situation shifts, and I wouldn’t take this trade anymore as of today, do I abandon my original plan and exit immediately or should I stay with the trade?

-C.

Here’s how I handle the “take profits or let them run” quandary.

Let me start off by addressing the “cut losses short” question. I don’t have all the answers, but I can tell you that for me, cutting losses means having an exit plan on the downside with defined risks.

We will all be wrong at times, but staying wrong is different. Don’t stay wrong! Limit your losses so that they can be overcome with reasonable winning trades. Don’t dig a hole so deep that you need a miracle to get out. That’s cutting your losses short.

Now let’s discuss early exits on trades like this where your conviction level has changed.

Occasionally, you’ll find trades like this which don’t completely fail (stop you out), yet don’t work either (move to your targets). Instead, they just begin to stagnate and enter into a trading range where your funds are tied up.

It can be a bit frustrating, simply because you’re left in limbo, wondering if the trade is in the process of failing or working. Each new red or green bar feels like the start of something meaningful, but they’re followed by the opposing color and you soon realize that price is simply showing indecision.

A key consideration to make when this happens is whether the character of the stock has changed. Stated otherwise, do you have a good reason to now lack conviction, or is it merely a mood shift for you?

A slow-moving trade is far different than one which may have just experienced an important technical event.

  1. Just because a trade isn’t developing quite as quickly as you would have wanted doesn’t mean it’s destined for failure
  2. The stock may be building a new pattern which you simply haven’t identified yet
  3. When I find myself in a trade which is starting to bore me, I know I’m overanalyzing when I start looking for signals which aren’t there
  4. If I’m positioned in accordance with the overall market (ie: long in a market uptrend), and if my trading capacity isn’t restricted because of this position (I don’t need to free up capital), then what I need to do is stay with the trade until a technical reason prompts an exit. I likely need to stay patient, as this is still a trade which can pay me

On the other hand, there are times when a premature exit may be warranted:

  1. When the stock has just seen a change in character, as measured by a technical event (high-volume reversal, for example), an adjustment may be called for
  2. If your trading funds are limited and you’d rather shift into a better idea, then you might consider closing out the trade in favor of another with more promise
  3. When you find yourself positioned in opposition to the prevailing market trend (ie: long in a market downtrend), then you have grounds to at least lighten up. That can be done either by reducing your position while maintaining your original stop and target parameters for the trade, or by tightening both your risk and objective

By Jeff White, trader and blogger, TheStockBandit.net

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