Reader question: how active with exits?

051414_1732_ReaderQuest1.pngLet’s go to the mailbag for a question. Reader Anthony asks:

I have a bit of an internal psychological dilemma going on at the moment. I place my stops usually around 3 ATR on pullback trades as I like to avoid the noise of the market. However, after a couple days I will ratchet the stop to take risk off in the trade. I have had a dilemma where some of my exits this year (winners and losers) have been exceptional. Where I am almost selling into the extreme and getting out at the perfect time. Consequently, I have probably the same amount of trades this year where I get out before a trade hits my initial stop .5-.7x R loss and the trade somehow manages to reverse and hit my 1R target. It seems the solution would entail being less active with exits but that some activity has taken me out of trades at the perfect time. Let me know what you thinkā€¦

So, here’s a concept that might challenge some of the conventional wisdom/thinking: in some sense, I think trade review can be harmful. (Stick with me a minute.) If we understand that the market is highly (but not completely random) and that much of what we see on a chart or experience whilst (just wanted to use that word, honestly) in a trade is random, then analyzing our trades deeply risks analyzing randomness. I’ve seen how a lot of people teach–armies of hopeful traders doing “trade review” hours after the market closes and trying hard to do more of their best kinds of trades. But what if it’s all just so very random?

That’s the conclusion I’ve settled on after many years. If you look at my trade history, I could create a book of very impressive looking trades–stops perfectly placed, multiple tests a few ticks before the stop level just before the market turns and runs to the target. Perfect trailing stops that keep me in the move and take me out a bar or two from the last gasp of the trend. Quick hit trades in and out, nearly perfectly timed. Of course, that’s one book… but there’s another. I don’t know how many times I’ve been stopped out at the exact high or low tick of the move, or have tightened my stop as a time stop, to be taken out on the “wrong side” of the bar that finally explodes in the direction of the trade, leaving me holding a loss while the market rockets through my first profit target. This set of trades looks like I had perfect understanding of the market, but I made the exact, wrong, stupid trade time after time!

Of course, the reality is somewhere in the middle, and that’s the point. We are never as bad as we feel on our worst days, nor are we as smart as we think we are during the winning streaks. This all averages out, and your final performance is the sum of many wins and losses, most of which balance out.

I think there’s a mentality in the developing trader community that basically says “pretty much anything works. You just have to decide what’s right for you.” I don’t think that’s quite true–there are a lot of things that don’t work, and a lot of things that work might only work in the right combinations with other things. (For instance, I’m not sure you could craft a good trend following system with small, fixed profit targets.) So, you do need to make sure that your entire approach/process/methodology has an edge. You need to verify that edge, and be comfortable in it, and then you simply need to apply it. Lather. Rinse. Repeat.

You identify this as a psychological issue, but I think it’s methodological–relating to your system or methodology more than your psychology. To specifically address this question, I don’t see an issue based on what you’ve presented in the question. Of course, it’s always possible you can refine what you’re doing and strengthen the edge; just make sure you are working over a substantial sample size and not putting too much weight on any one trade–trade review might help more than it hurts, in many cases.

AdamHGrimes

Adam Grimes has over two decades of experience in the industry as a trader, analyst and system developer. The author of a best-selling trading book, he has traded for his own account, for a top prop firm, and spent several years at the New York Mercantile Exchange. He focuses on the intersection of quantitative analysis and discretionary trading, and has a talent for teaching and helping traders find their own way in the market.