Its all about EXITS!! | Forex Factory

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Its all about EXITS!!

  • #1
  • First Post: Nov 6, 2007 7:04am Nov 6, 2007 7:04am
Few new traders realise the importance of exit strategies when designing/trading a system. Afterall, without exits, how would one get profits? If you want to maximise profits your exit strategy is as important, if not more so, than your entry.

The well sung axiom of let your profits run and cut short your losses is essential in winning in trading given that trading is a game of probibilities. You have to look at the bigger picture to win, i.e you have to lose to win and if you don't lose well you will not win. If you take 100 trades and 90 of those trades are losses but your 10 winners are larger than your overall losses then you have your losses smaller than your winners which is the ultimate aim of trading. Exits are therefore vitally important whatever winning % of your system. It can be big or small but its your exits that determine if you win or lose.

Whilst many traders don't even register the importance of their exit strategy in their system, many other traders tend to scale out their winners in order to lock in profits. However, This type of exit is one in which you enter the market with multiple contracts and then scale out with various exits. But if you step back from this sort of exit and really study it, you’ll see how dangerous this type of trading is. What you are actually doing with this sort of exit is practicing reverse position sizing. You are making sure that you will have multiple positions when you take your largest losses. You are also making sure that you only have a minimal-sized position when you make your largest gain. It’s the perfect method for people with a strong bias to be right, but it doesn’t optimize profits or even guarantee profits over the long term as you are not maximising profits over your losses.


If you analyse your system with some back-testing or look at past real-time trades determine whether scaling out of positions is really the right thing to do over the long term for your system.


Would like to hear your thoughts...

  • #2
  • Nov 6, 2007 8:19am Nov 6, 2007 8:19am
Exits are key. Imo, the most important rule to any exit strategy is to minimize losses. The next important rule is to maximize gains. Many confuse those two rules by scaling out to early, they think that if they take 50% as quickly as possible they minimize their losses and book some profit. While is entirely true, it is also true that doing it like this profits were also minimized not only the losses. Scaling out is not bad if the right balance is found.

About scaling in, this one is tricky, I am not entirely confortable with, still testing. The idea here is to try to catch a trend and scale in with parts as the market moves in your favor. Easy said, much harder to envision and implement.
Lets say I split my position in 3 parts, put the 1st part into the market. At this moment the risk is 1R, so I lose 1R if I get stopped. Now lets say the market moves in my favor. When the market has moved 2R, I move 1st part to BE + 1R and in the same time put in the market the 2nd part. At this point the risk is 0R because if I get stopped out I will be +1R on the 1st part and -1R on the 2nd part. As you see, the losses are minimized as we scale in, very important. The market continues to move in our favor reaching 4R since we put the 1st position and at this point we move the stop of both open positions 1R behind the price. Thus we have 4R of guaranteed profit. And also we land into the market with the 3rd part and if we get stopped out we will not have a loss but rather a profit of +3R (4R - 1R). The market continues to move in our favor and reaches 6R since the starting point, here we have a net profit of 6R + 4R + 2R = +12R of our initial risk. We either continue to trail it or close it. The main point is we can reach a +12R profit with a risk of 1R that exists only in the beginning of the process, very important.
Trading = a mirror to your human flaws. Fix them or be fixed.
  • #3
  • Nov 6, 2007 9:09am Nov 6, 2007 9:09am
Quoting soso
Lets say I split my position in 3 parts, put the 1st part into the market. At this moment the risk is 1R, so I lose 1R if I get stopped. Now lets say the market moves in my favor. When the market has moved 2R, I move 1st part to BE + 1R and in the same time put in the market the 2nd part. At this point the risk is 0R because if I get stopped out I will be +1R on the 1st part and -1R on the 2nd part. As you see, the losses are minimized as we scale in, very important.

Soso, I think you are missing something, when you move your stop on the 1st position to B/E and if stopped out there, you are not at 1R but at 0R and -1R on the second position, so your overall would be -1R, not 0R.

I am also a complete believer that exits are a key to any system (amongst other vital parts) and when I build a system I first think about the exit strategy as the foundation of the system. About scaling out, I have done this and it is a valid method, but, to be effective assuming your Reliability (win/loss rate) is around 50%, you must not begin scaling out until the whole positions are at least beyond +1R. The alternative is to scale out on the loss side up to -1R but not beyond. When I did the scaling out, it was a psychological boost as I felt great about my entry position and re-enforced my reliability and need to be right, but it did greatly effect my expectancy (in a bad way) as I wasn't letting profits run to their maximum potential and conversely on the losses I let the whole position go to the -1R. I have since recognized this little flaw and my Expectancy is where it should be as I no longer scale out but let the entire position run its course. I am not stating that scaling out on the + side has an overall negative effect, but your system must be designed to reflect this and scaling out must be done beyond the +1R. That's what works for me.

Cheers,
NP
  • #4
  • Nov 6, 2007 9:24am Nov 6, 2007 9:24am
Quoting Porkpie
Few new traders realise the importance of exit strategies when designing/trading a system. Afterall, without exits, how would one get profits? If you want to maximise profits your exit strategy is as important, if not more so, than your entry.

The well sung axiom of let your profits run and cut short your losses is essential in winning in trading given that trading is a game of probibilities. You have to look at the bigger picture to win, i.e you have to lose to win and if you don't lose well you will not win. If you take 100 trades and 90 of those trades are losses but your 10 winners are larger than your overall losses then you have your losses smaller than your winners which is the ultimate aim of trading. Exits are therefore vitally important whatever winning % of your system. It can be big or small but its your exits that determine if you win or lose.

Whilst many traders don't even register the importance of their exit strategy in their system, many other traders tend to scale out their winners in order to lock in profits. However, This type of exit is one in which you enter the market with multiple contracts and then scale out with various exits. But if you step back from this sort of exit and really study it, you’ll see how dangerous this type of trading is. What you are actually doing with this sort of exit is practicing reverse position sizing. You are making sure that you will have multiple positions when you take your largest losses. You are also making sure that you only have a minimal-sized position when you make your largest gain. It’s the perfect method for people with a strong bias to be right, but it doesn’t optimize profits or even guarantee profits over the long term as you are not maximising profits over your losses.


If you analyse your system with some back-testing or look at past real-time trades determine whether scaling out of positions is really the right thing to do over the long term for your system.




Would like to hear your thoughts...


if you take 100 trades, assuming you are using 2% MM risk you are out after 50 of consecutive losses, in fact you are supposed to stop everything after 10th consecutive loss, and rethink your strategy. plus, if you take into account the fact that any conventional broker ( not ECM but market maker ) hunt all your stops, you'll get in serious trouble with your strategy, 90 losses of 30 pips and ten wins of 300 pips each...

oops i just seen that 300 pips ( simple math here 90*30=2700 < 3000/10 ) is too much for a single trade in real world of stop hunting brokers, so i completely diagree with your strategy.
The risk is what gives value to an investment.
  • #5
  • Nov 6, 2007 9:32am Nov 6, 2007 9:32am
Quoting soso
Exits are key. Imo, the most important rule to any exit strategy is to minimize losses. The next important rule is to maximize gains. Many confuse those two rules by scaling out to early, they think that if they take 50% as quickly as possible they minimize their losses and book some profit. While is entirely true, it is also true that doing it like this profits were also minimized not only the losses. Scaling out is not bad if the right balance is found.

About scaling in, this one is tricky, I am not entirely confortable with, still testing. The idea here is to try to catch a trend and scale in with parts as the market moves in your favor. Easy said, much harder to envision and implement.
Lets say I split my position in 3 parts, put the 1st part into the market. At this moment the risk is 1R, so I lose 1R if I get stopped. Now lets say the market moves in my favor. When the market has moved 2R, I move 1st part to BE + 1R and in the same time put in the market the 2nd part. At this point the risk is 0R because if I get stopped out I will be +1R on the 1st part and -1R on the 2nd part. As you see, the losses are minimized as we scale in, very important. The market continues to move in our favor reaching 4R since we put the 1st position and at this point we move the stop of both open positions 1R behind the price. Thus we have 4R of guaranteed profit. And also we land into the market with the 3rd part and if we get stopped out we will not have a loss but rather a profit of +3R (4R - 1R). The market continues to move in our favor and reaches 6R since the starting point, here we have a net profit of 6R + 4R + 2R = +12R of our initial risk. We either continue to trail it or close it. The main point is we can reach a +12R profit with a risk of 1R that exists only in the beginning of the process, very important.
MMmmm Very interesting. If I understand the concept fully, I think this method is suitable for very strong trending markets to capitalise on it well. I suppose it all depends on whether you would be better off using your capital for other trades that seek the potential for getting in on strong trends early on and trailing your stop, rather than scaling in with multiple entries on a trend that will have a higher probability of weakening along the way, a risk factor not easily calculated from the inception of a multiple entry trade.

I suppose it depends on what time frame you are using and corresponding long term/short term trends. Also, placing your stop per position at breakeven everytime you make R1 might not be conducive to the volatility of the market at that time. I presume some discretion would be needed for entry at each R1 stage otherwise the system would completely negate the need for 'market conditions' or price behaviour as an entry rule possibly creating low probability setups for those trades. And like wise, if exits are purely based on the other trade meeting R1 there is no consideration for market behaviour and whether to close trades i.e trail or tighten stops. I need to think about this one....
  • #6
  • Nov 6, 2007 9:46am Nov 6, 2007 9:46am
exits, entries, all the same mathematically.

we had this debate a few months ago: http://www.forexfactory.com/showthread.php?t=38152

Relax and be happy.
  • #7
  • Nov 6, 2007 9:47am Nov 6, 2007 9:47am
Quoting 3cent
if you take 100 trades, assuming you are using 2% MM risk you are out after 50 of consecutive losses, in fact you are supposed to stop everything after 10th consecutive loss, and rethink your strategy. plus, if you take into account the fact that any conventional broker ( not ECM but market maker ) hunt all your stops, you'll get in serious trouble with your strategy, 90 losses of 30 pips and ten wins of 300 pips each...

oops i just seen that 300 pips ( simple math here 90*30=2700 < 3000/10 ) is too much for a single trade in real world of stop hunting brokers, so i completely diagree with your strategy.
The 100 trade senario was just an extreme example. Once you know your % of wins and your expectancy i.e the amount of potential win in $ per $ risk then you would know your postion size accordingly for you to trade your 10% win safely and allow for your 90% loss. By knowing this you have some idea of how your system trades and therefore would not need to stop after 10 losses because you expect X number of losses to win. If you try and trade to win every trade, psychological factors will kick in and sink you, resulting in a fear of losing, resulting in missed trades that could have been the winning trade that you need to be profitable for the day, month or year.

You are right to bring in other factors such as 'stop hunting' if that likely to happen to you (depends largely on your broker and your time frame). You have to extract the costs of slippage and transaction costs to understand whether a 10% winning system will be profitable on a short or large time frame. Again, I am using the 10% win scenario as an extreme case to point out that winning boils down to how much profit you make over the AMOUNT of your losses regardless of a system's win to loss occurrence ratio.
  • #8
  • Nov 6, 2007 10:04am Nov 6, 2007 10:04am
Quoting merlin
exits, entries, all the same mathematically.

we had this debate a few months ago: http://www.forexfactory.com/showthread.php?t=38152

Thanks Merlin. I had a quick scan. Interesting stuff. I suppose it all depends on your strategy. If you think your system for entry has a high probability for profit when getting you in you might use a similar method to get out, whatever indicators you use. If the reason for getting in the trade is no longer there then get out. Others simply use targets based on S/R levels, fibs, the moon and the stars etc. I think its best to diversify. If you use a number of different techniques for entry dependent on mkt behaviour at that time then you might have tested that entry alongside several exit techniques to find the best exit strategy for that particular market or market behaviour. A multitude of entrie techniques with a multitude of exits to a multitude of markets and market behaviours. Flexibility and simplicity is the key I think.
  • #9
  • Edited 12:51pm Nov 6, 2007 11:19am | Edited 12:51pm
Hi. Thanks for starting this Porkpie. I just want to add my voice as to the importance of exits, and to say that the realization of this has turned my trading around. I was trading a good system and had gotten pretty good at reading the charts, seeing the signals, etc., but I still wasn't consistently profitable. I finally figured out that the problem was that I was exiting profitable trades while they were still going up. I would get into positive territory, take some early profit and move my stop to break even, patting myself on the back for so astutely managing my position. Then, the rest of my trade would usually stop out at break even, and that was it. Sometimes it would run to a pre defined target I had and then I'd really congratulate myself.

The problems came on the losers, which would routinely stop out at my initial stop with a full load of lots, and totally messed up my expectancy numbers. I was trading at 70% winners but still getting nowhere. Actually, I didn't understand expectancy until I read an article on it http://www.forexfactory.com/showthread.php?t=44081 . When I calculated my expectancy numbers, I realized the problem and began trading a different way, adding to my profitable positions rather than exiting, then getting out when the market tells me to, not where I 'think' it should go. This way, when I am wrong and the trade goes in the other direction, my risk exposure is smaller (more managable), but when it goes my way, I can add to my position and ride the move with as much in the market as my risk paramaters allow.

So now, at least on longer term trades (4H and above), I never exit a long trade on a green candle, or a short on red. Why would I want out of a profitable trade just because 'I think' it's over? Having said that, I will mention that I do still scale out on 15 minute trades, using two positions and exiting the first at 1R, then moving to break even and letting the second run, usually just to 2R. I don't do these trades too often, and usually as a hedge to my longer positions. However, after reading soso and Northpro's posts I may try and tweak this a little.

3cent, I see that Porkpie has answered you already, so I want to encourage you to look into this carefully. It's made all the difference in my trading. And if you haven't had a 300 pip winner yet, it might be because you're scaling out too soon!

Keep the discussion going! By the way Merlin, I do agree that mathematically speaking, entry and exit are equally important, it's just that more emphasis seems to be put on entry. How about this;

When you're not in a trade, entry is most important.
When you're in a trade, exit is most important.http://www.forexfactory.com/images/icons/icon10.gif


Richard
  • #10
  • Nov 6, 2007 3:29pm Nov 6, 2007 3:29pm
hmmm...

let me help these newbies,

Exist strategy are very easy to make. Just know your risk per trade, and then your avarage loss per month.

Then you have to know your ROE or a goal a year. With a good math, you should know your risk/reward ratio. Convery that magic ratio to target pips + trading lots size. Close your trades manually when your trades have reached your target.

Easy!
Trainee at UBS Investment Banking
  • #11
  • Last Post: Nov 6, 2007 7:08pm Nov 6, 2007 7:08pm
Quoting 3cent
if you take 100 trades, assuming you are using 2% MM risk you are out after 50 of consecutive losses...
Not quite. If you suffer 50 consecutive losses, where each loss decreases your current account by 2%, you will still have .98^50 = 36.4% of your original account.
Domo Arigato, Mr. Roboto!
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