In response to my article on stops last weekend, a coaching student of mine wrote on the blog about using a 50 day moving average as an exit. Although seemingly doing pretty well (reported just closing a +35% trade), she commented that in two instances when a position had penetrated the moving average she waited a couple of days "hoping" the stock price would rise and when it didn't, finally took the larger loss. That makes my student the member of a large club whose members, on occasion at least, have failed to do what they originally had planned to do in cutting a loss.
Who among us can say that they have never been a part of that club? To those who can, I applaud you because I firmly believe that following one's exit plan can be a critically important element in trading successfully. I blame our failure to adhere to our original exit plan even once a price has passed our pre-determined exit point on that 'little voice' inside us that often encourages us to hang on because "it'll come back." That is the voice of emotion and it can be very difficult to ignore. We just don't want to take that loss even though we know intellectually that it may lead to an even bigger loss down the road. We "think" it will come back but seem to fail to consider that it could also continue to move against us.
If we set our exit strategy before we ever enter the play, we are doing it at a time when our emotions are not so strong. We are doing it out of the heat of battle when we can see a reason for our discipline. Following that discipline rather than the voice of emotion during the gyrations of a trade can help us to make better trades. Changing from the thoughtful discipline constructed as we planned the trade means we are no longer willing to accept our thoughtful decision because it will require us to take a loss. The point was, however, back as we were planning our trade we understood there was a risk and we decided exactly how we would attempt to limit that risk to a specific level. In the heat of swirling emotions during a trade when things go as we thought they would not we are susceptible to the suggestions of our 'little voice' whose advice I have often heard but have found to be mistaken quite regularly. Suddenly, we decide to let a loss run because "it [might] come back." Might not, too.
When we listen to the 'little internal voice' and stay in a trade beyond the point where we had previously chosen to exit we are making a decision to let our losses run. All too often the loss goes from dimes to quarters to dollars or worse. How about getting out when and where we planned to cut our losses and then getting in when it turns our way again. I've heard it said that some of the best traders will enter or re-enter a position 4 or 5 times before it goes their way.
Setting the exit strategy, the discipline, is extremely important in my view, but it is useless if we then fail to follow it. It seems equally important that once set the discipline be followed. I definitely do not mean this as a criticism. That little internal voice is probably in us all to one degree or another and it is one of the things that makes us human. My advice is simply to be aware that it is there and that while ever present it may not always suggest the best course of action, especially in our trading.
by Bill Kraft, Editor
Copyright 2010, Makin' Hay, Inc.
All Rights Reserved
P.S. Save $50 PER MONTH on my subscription trading newsletters!
SAVE on my Under $10 Stock Trader Service!
SAVE on my Option Trader Service!
SAVE on my Trend Trader Service!
Technorati tags: stock trading stock market investing trend trading swing trading option trading stock options stock option trading Bill Kraft
To comment on Bill's article click on the "comments" link below.