The Fine Art Of Exiting
From www.adtrading.com:
When it comes to entering a position, we always harbour a certain flush of optimism that this trade will be the one which garners a splendid profit. However, when it comes to the crunch, many of the big losses we can suffer are as a result of sheer paralysis. A loss making position is allowed to continue haemorrhaging until it eventually causes a huge dent in our book. Similarly, we often itch to get out of a position too early, just to book a profit, when - in fact - there is a great deal more to be made just by sitting tight.
Of course, there are issues to be addressed upon trade entry such as:
Ensuring that you only countenance trades which meet a pre-defined risk / reward threshold. (This also gives you an idea of a potential return on the trade, even if it may not be met, or indeed ultimately exceeded.)
A firm risk point of some denomination at which the trade is deemed to have gone awry - this may be in the a form of value stop, a time stop, or indeed a simple negating signal.
When it comes to exiting a position, there are a number of issues which have invariably built up. Perhaps the most important of all, however, is the way in which we develop an affinity for our trades.
It is always dangerous, but equally hugely tempting, to covet a trade. So traders can naturally be paralysed from either cutting losses, or taking profits. This is particularly true of buy and hold strategies, where the owner begins to identify with, for example, a company's management or the government issuing a bond. The art of exiting a position requires new information to create a 180 degree reversal in this perception. For many traders this can be difficult.
A potentially useful way to lessen affinity with a position is to try and visualise it simply as cash in waiting. While you own it, it has a certain relationship with its cash value. Once you exit, the position realises a specific dollar amount. This can be very helpful with the likes of stock instruments, where traders can most often find themselves coveting their position in a particular market because they perceive its media coverage, its management, or whatever to be favourable.
The same can be true of commodities. The number of investors who regularly take a hammering in, say, precious metals - just because they love the aura of holding gold futures - is unbelievable. A damning indictment if ever there was of investing dollars in something just because you like it!
Then, there's the angle of speaking to your friends. Nowadays, I never discuss any of my positions with outsiders. True, this is difficult. A lot of people think I'm being arrogant or rude, but in fact there are several very good reasons for this. For example, I don't want to build my position into a feedback loop which may ultimately 'entrap' me. For instance, if I meet a few trading friends (or even others, such as family members, as non-traders have much less understanding of the flexibility required for good trading) and say "I've just sold XYZ short", I then have an emotional stake in the success of this trade in front of my friends. It's much easier to keep mum, so I don't feel as if I am building a public affinity with a particular position.
Reflected Glory
This is one of the big dangers which can come from holding a particular position. For instance, Mr. X owns a stock because Warren Buffett holds it, or Ms. Y is short bonds because she has heard that George Soros is too. I have covered the 'smart money' concept and what is wrong with it before. However, reflected glory is moving one step further, as the trader believes that he is not just safe, but looks smart too. Unless you can tell when George Soros is going to close his position with substantial accuracy (even leaving aside the fact that Quantum has taken some mammoth baths over the years), or can hold on for the same lengthy periods as Berkshire Hathaway, avoid this like the plague.
Being Right Means Always Being Wrong!
Even those who don't wish to identify themselves as contrarians per se, must still demonstrate a substantial 'contrarian' angle in the manner in which they exit positions. After all, to exit a position which is performing well is to exit one which, by its very definition, a lot of others have also entered - and are quite likely volubly exhorting others to enjoin and/or stay with. So you are placing yourself in a situation where you must go against the crowd to sell out of a market which is essentially strong, or buy back a commodity which is basically weak.
A huge problem with closing out a position is that you can't ever hope to get it right! After all, even if the market moves up a mere tick after you sell out, you can still see that you've missed the high. In most cases, the market will continue on for quite some time before it turns around. So no matter what your reasons are for exiting, you can easily find fault with yourself for not managing a perfect strategy.
The point here is that, no matter what and when you trade, you will probably not be fortunate enough to pick the precise lows or highs more than a couple of times in your career. If you want to indulge in self-flagellation over the fact that you have missed some points, then you are not sufficiently mentally stable or strong enough to be trading. So go fishing (or follow some other relaxing pursuit) until you can trade without beating yourself up.
Nobody is tick perfect, not even the absolute greats. Indeed some of the exit points chosen by world class 'A' set traders often look bizarrely bad. The point is, however, that they regularly book good profits against puny losses. Indeed, often they are sufficiently ahead of the game to not merely leave a few crumbs on the plate for others, but in fact leave some veritable slices of bread while they wait for the next profitable opportunity. And the fact that, in screen-based trading, orders are handled on a first in, first out basis means that even the most brilliant former floor locals have significantly less chance of being able to execute their trades at the absolute tops or bottoms of markets.
The more you think about a particular position, the more you will create an affinity with it. The longer you hold a position, the greater that affinity will be. If you have a long-term holding in, say, a commodity or stock index future, for instance, you may find yourself becoming sucked into losing your objectivity. And in this context, "long-term" may only mean a matter of a few days, or less, for those professionals trading intraday.
Denial
Ultimately, we can get to a point where we've seen the position ride out set backs and, so far, it has always recovered. However, this isn't a positive process like plant cultivation or child rearing, where a continuing process of positive nurture will always result in the trade going our way. Outside shocks to the system are potentially enormous in the trading environment and, no matter how large you regard your position as being, it is never going to be big enough to corner the massively liquid global markets. You must, therefore, remember that - despite the feedback loop coveting your position creates - the end result will always be that you have no influence over the value of your holding. And sooner or later its price will move in the opposite direction to the one you originally hoped it would follow.
Covert Covetousness
Watch out also for covetousness being concealed by other thoughts. Often traders become reluctant to close a position, stating relatively ponderous reasons. Brokerage costs are one of them... but in this digital dealing era, relatively few folk ought to be remotely concerned at the extent of these expenses. A second covetousness trap is the taxation issue. If you have a big problem with this, then get yourself a better accountant, or move your trading offshore. But don't hang onto positions and risk your profits just because it will add to your tax bill. This is a lose - lose situation if ever there was - and one which is mostly just a drain on morale.
Thou Shalt Not...
Not coveting a neighbour's ox is a commandment in Christianity. With trading financial markets, the effect of coveting one's own trades is a very dangerous prospect. When valuing your portfolio or reviewing recent trades, always keep an eye out for those warning signs of becoming fond of a trade. After all, there always comes a day when chickens, cows or whatever - no matter how much affinity the farmer feels with them - are ready for sale or slaughter. You need to focus on your positions with the same degree of objectivity at all times.
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