Saturday, December 13, 2014

Getting out on time

I've posted this chart up as an example to show you why you should always heed any exit signal you get to denote a trend has finished.

This is a UK stock, which formed a great set up during October, and then sprang into life in November. The trend stalled and then generated an exit signal at the beginning of the month.

Some people might have been tempted to hold on, thinking this was just a pull-back within a major uptrend. That might still be the case, and will depend upon your timeframe and parameters, but how big a pullback do you want to suffer before you throw the towel in? If you do hang on and override the exit signal given, who's to stay that price will completely reverse trend again back to the downside?

If you didn't heed the signal, you'd probably now be thinking "if only..." and berating yourself for not getting out at a better price when you got the signal.

Why give yourself all that stress and frustration? Trend followers have clear rules telling them when to enter, and (more importantly), when to exit. They act on those signals in an unemotional, objective manner. They know they will never get out of a profitable trade at the extreme of the move, but by the same token they don't want to give the market the opportunity to take all those profits back. Price generally does not move straight up or straight down. Within an uptrend there may be minor pullbacks or corrections. The logic of a trend follower's rules means they allow a certain amount of this price noise.

In this example, over the course of a month the trade would have yielded just over 5R - a nice reward for not a lot of work. If you had still been holding on, then this would have evaporated down towards 3R - still good, but only 60% of what it could have been had you taken the exit signal that your rules dictated. Do that several times over the course of a year, then that makes a huge difference to your returns!

By the same token, you don't want to get out too early in a new trend, for fear of losing what profits you have made. Who knows, this could have ended up going up a lot further, and have been the biggest winning trade of the year. You never know - trend followers never predict. A trade that yields a +20R return covers a lot of small losses and should leave some profits left over. That is how trend following works.

Remember its a lot easier to look at your trades dispassionately if you have good risk control. If you are risking only a small amount of your equity on each position, you should be able to develop an 'emotional indifference' towards your trades. It then comes down to making sure you exit not too early, or too late, but on time.

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