By Don Dawson, Online Trading Academy Commodity Futures Instructor
One of the hardest tasks a trader faces is exiting his trade if it is profitable. Obviously, if we have a losing trade our protective stop will take us out of the market with a small loss. This is how the professionals stay in the trading business so much longer than the inexperienced traders; they manage their losses.
Many times we are trading one contract and when the price comes to our exit price we start wondering what will happen when we get out. Will the market keep going and will I miss more profits? Has the market reached its target and is now ready to turn? We never know what the market will do at any level. We just place our trades based on a sound strategy and money management and then remember that trading is a probabilities business. One or two trades should not make or break any trader. Use a series of trades to judge your performance and you will not be trying to tweak your strategy or second guess yourself with every market price change.
As you read this, I would like you to keep in mind that in order to trade multiple contracts you must have the proper account size and trading experience. If you try and trade multiple contracts before meeting these pre-requisites, you will lose money very quickly in these leveraged markets. My general rule of thumb is to have $10K for every Futures contract you trade. If you try and trade with any less you will be trading scared money because every loss becomes significant to you. For example, the ES (E-mini S&P) is $12.50 per tick per contract. Now multiply that out to 3 contracts. You are now exposed to $37.50 of risk per tick. With one contract you might only risk $125 per trade and with 3 contracts your initial risk is now going to be $375. This does not sound like much until you have a series of consecutive losses (it can and does happen) and you realize your account is now down over 35% - 40%. There is no hard rule as to how much time must pass before you can trade multiple contracts, but in my opinion if you can turn your $10K into $20K while following your plan and using good money management skills, then you are ready to move on.
There are two types of exits you can use while trading.
All out means that if you enter the market with 2 contracts and reach your profit objective, you exit all your contracts at that price and then wait for your next setup to enter the market. As you can see in the chart below, we had a signal to buy at 991.00. Our strategy says to exit all of our contracts at 996.00.
Figure 1
Pro |
Con |
Easier trade management, less risk of order errors |
Could leave large profits on table if market keeps moving in your direction |
If market turns at your exit, you keep all the profits |
Works well if market is in trading range; if trend develops, you miss opportunity |
Figure 2: Pros and Cons of Exiting All Out
The other exit technique is called scaling out. By doing this you are taking profits at different price levels as the market moves in your direction. I like to use 3 different levels to exit and manage my trades. The charts below will show you how I do this and why. Obviously, the more market volatility there is the better the chances of us reaching all our targets on a more regular basis. For example, the ES has dropped drastically in its average daily range from October of 2008. At that time we had a 90 handle (point) range per day! As of this writing, we are seeing about 16 handles (points). Does this mean we cannot obtain our targets? Not at all, but it does create challenges.
In class I refer to each set of contracts that I will exit at a particular price as "Units." These Units will vary in the number of contracts traded due to how I perceive the risk/reward of the trade. For example, the first Unit that I will exit may have 2 contracts, the second Unit may also have 2 contracts and the third Unit might only have 1 contract. Of course, it could be any number of contracts in each unit. I find it easier to discuss units rather than contracts in class. From the psychological side of this, it is a lot less stressful to say, "We are exiting 1 Unit at this price,” than “We are exiting 5 contracts at this price." Anything that can keep our minds off of the money or size is important.
This next chart will show where I like to exit my first Unit. We will look at this from the buy side so just reverse for a sell exit. My style of trading is intra-day trend trading. I look for pullbacks in a trend to enter my positions. This way I can get in a little earlier than the people buying or selling the breakouts of these moves. This allows for a free look at the breakout and a chance to see if it is valid or not without being under water when it fails quickly. My first target is always the last swing high since my entry. Initially when I enter the market, I have a predefined stop loss point that I enter at the same time as my trade is entered. Once the market moves to my first target objective, I immediately exit 1 Unit at this price and move my initial stop loss to breakeven plus one tick to cover commissions.
Figure 3 Now we have exited 1 of the 3 Units and taken profits at this level and moved our protective stop to breakeven plus one tick to cover commissions. We virtually have a free trade now. The second Unit will be exited at my 1:3 Risk/Reward target. If I am going to initially use a 3 handle (point) protective stop, I will set this 1:3 target at 9 handles (points) from my entry price. It takes a lot of patience to sit and wait for this level. I have found that by waiting for these targets to be reached, we can make up for all those days that we had some small losses and still add some money to our trading account. The chart below shows our second Unit exit point.
Figure 4 Now we have exited two of the three Units for profits on all of them. Not just emotional levels of profits but logical exit points. If you look at where the first Unit is exited and the protective stop is moved to breakeven plus one tick, you will perhaps see why I do that. The reason to exit here is simply that if this market comes up to the last swing high and fails, we have a potential Double-Top pattern forming. I do not want to give back any profits if this pattern meets its downside objective. The second Unit exit is at our money management target. We must always try for this 1:3 risk/reward target even if we do not hit it all the time.
Our last Unit left now becomes our runner. As I said earlier, nobody can tell where a market will stop. A couple of times a month we have days that are referred to as Trend Days. These days open on the high or low of the day and continue to trade in the opposite direction all day long, usually closing on the extreme opposite end of the opening price. I nicknamed this last unit "Lottery Ticket." If you have ever played the lottery you probably know why. More times than not, the ticket will not be a big winner. However, if you don't play you cannot win, right?
When you allow this last Unit to run, you can sometimes have a trade that lasts all day long and all you have to do is sit back and adjust the trailing stop. These days lead to huge profits simply because you have already made good money on the first two Units and now you have this Unit just adding up the ticks for you right into the close of the day. In the chart below, I will show how I move my stops with the market. The technique is referred to as a Trailing Stop. There are automatic trailing stops and manual trailing stops. The automatic trailing stop adjusts automatically by a pre-set amount of ticks you select. The manual is moved each time you create these new swing highs and lows. The manual trailing stop is more efficient because it is based on support and resistance. The automatic trailing stop is more random. This trailing stop just follows the market in the direction of your trade, locking in more profits each time it is adjusted. In the case of this buy signal, we will be moving our Trailing Stop with each significant, new high. On this last Unit, I will give the market as much room as necessary because I have already made good money on my first two Units. The Trailing Stops are placed at very significant points in the trend. You will notice that some of the new highs are only by a couple of ticks. I do not move my stop until there is a significant move beyond the previous high. This keeps you from being stopped out by random market noise.
Figure 4 By allowing your exits to be scaled out, you can compound your profits by taking advantage of the trend. Keep in mind that the markets do not trend every day. This strategy works well on the strong trending days. On the more choppy days, you will find this technique usually gets to the first target and then comes back to your breakeven. You make money on one unit and break even on the others. Then there are days when you will lose because the entry did not work. This is part of trading and you must accept there will be losing trades. Remember to have small losses and let your profits run as far as they can.
This is my style of exiting a market. Eventually, the volatility will return to our markets and when they do, we will be prepared to take advantage of it.
"Some men have thousands of reasons why they cannot do what they want to, when all they need is one reason why they can." Mary Frances Berry
- Don Dawson
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