Sunday, January 11, 2015

Let those profits run!

We have seen a volatile start to the new year in the major market averages. These gyrations in the market have been increasing in intensity and frequency over the last few months - pullbacks and sharp reversals have been seen in early August, the first part of October, mid-December and now from the beginning of 2015.

Given my own goal for this year of concentrating more on the price action in the stocks I am looking to trade rather than the indices, these market movements have been noted but have been of less importance and relevance to me than before.

As it is, one or two trades have failed (which can happen with any position), but my most profitable trade has continued to inch up regardless of the general market volatility or movement, and is now over +6R in profit on its own.

Some people will have observed what is happening in the general market and may have been tempted to take such a profit off the table for fear of it evaporating, but that is not how trend followers should think.

Their method will ensure that they keep their position until such time that an exit signal is generated. All the while, the trailing stop is moving up and, barring any 'gap down' through that stop level, then an ever-increasing amount of that profit is being locked in.

Now, it may be that the stock stops moving up and reverses from here. Then again, it might continue trending to the upside. Who knows?

I opened one such trade at this time last year which ended up generating an overall profit in excess of +19R, and ultimately ensured I made a profit in 2014. In effect, this single trade covered all the losses that followed in the second half of the year.

Had I taken the view that I should taken some quick profits for fear of losing them, then the chances are I would have got out of that trade way too early, with the consequence that, instead of making a profit for the year, I would have ended up with a loss.

Traders who were able to get into a short crude oil position a few months back will also take comfort that that single trade will cover an awful lot of small losses, and help them generate an overall profit in 2014 and into early 2015.

People who want to utilise a trend following method need to accept that typically achieve a high win rate between 30% and 40%. This will be whether you trade stocks, commodities or forex. Therefore you need to ensure that you have the ability to take those small losses, and also have patience and discipline to let the profitable trades play themselves out. If you can't, then you won't be profitable - you will destroy the overall expectancy of the approach.

A trend follower's goal should be to strictly limit the downside at all times, but to not place any limits on the potential upside. Therefore, there is no doubt that the correct plan of action is to keep the position open until the exit signal is given. By doing that, then you are giving yourself the best opportunity to maximise the profit in a developing trend.

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