Wednesday, January 08, 2014

Trying to let profits run

Below is the chart of a UK stock which broke out shortly before the holiday period and moved up sharply, only for price to reverse and erode the bulk of those gains in the first few days of this year.

Such movements can and do happen, and as a trend follower you need to be prepared to accept and deal with them. As you can see, the current price is above the trailing stop, therefore the trend remains intact. However, it is quite possible that if price moves down tomorrow then the position will be closed.

No doubt some traders will say (with the benefit of hindsight) that it made sense to exit the trade at the top of the move a few sessions ago. The problem is, when a big trend takes off, you can never predict how long and how far that trend will run. Trying to time the top of a move could easily lead to taking profits too early. Should price in this stock rebound and move up to new highs, then potentially you are now on the sidelines, on the outside watching in.

Sure, it is frustrating to potentially have lost those profits, but in the long run, staying with the trend, and obeying your exit signals, will lead to better returns.

Remember that the basic tenet of a good trend following system is to cut losses short, and let profits run. Richard Dennis used to tell the Turtle traders to be prepared to lose 100% of your profits on an individual trade, which could reverse and even end up generating a 1R loss. I cut any losing trades quicker than that, but the principles are exactly the same.

Providing the uptrend is not invalidated, with no exit signal given, then you need to avoid thinking "if only I had exited back there...". Quite soon, you will end up in a trade like this, and will try and predict a good exit point, only to ultimately grab a small element of a huge trend.

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