Tuesday, June 10, 2008

Letting profits run

A trend follower never knows how long a trend will last. The old trading adage "Cut your losses, and let your profits run" is hard for inexperienced traders to follow. All a trend follower can do is control his (or her) risk, enter the trades at the appropriate entry points, follow their stop placements and see what happens. The trend may last a few days, or (hopefully) several months.

Psychologically, trend following is difficult to adhere to. I have found myself bailing out of profitable positions way too early, partly to bank profits, but mainly when I have been scared of a reversal, usually in the general market indices.

A classic example is Dryships (DRYS) a US listed shipping company. I bought at around the $22 level during the Febraury 2007 mini-correction, as it was making new highs, which I viewed as positive relative strength to the market.

The stock rose and was sitting comfortably in profit, however a few weeks later, during a weak day in the market, I panicked and bailed out of my position.

What happened? DRYS went to $130 in a few months.

I could name a few others similar to this as well.

Part of the reason I exited way too early was that I had too big a position in relation to my trading equity, and couldn't bear the though of seeing my profits vanish. Fortunately, in this case, I was able to get back in when another entry signal was given - but by using a more appropriate level of risk!

Now with my level of risk under control, I'm hopeful that, when in a similar position in the future, I will be able to sit through the temporary retracements (providing my stops are not hit), and will be able to make the substantial profits that all traders look for.

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