working system, money management will make more of your bottom line than the
actual entry and exit rules themselves.Taking a Profit
I don’t know about your trading habits, but taking a profit is not the most common
reason to exit a trade in any of my systems. I wish it were, but I’m afraid it never
will be.
In my opinion, only two ways exist to take a profit. Technique number one is
to work with a profit target that lets you exit with a limit order. Technique number
two is to work with a trailing stop that moves in the direction of the trade, trailing
it at some specified distance. A trailing stop is probably the most common tech-
nique to exit a longer term trend-following trade. However, a trailing stop can also
result in a loss, depending on how the trailing stop is designed and if it also can
operate as a stop loss during the initial stages of a trade.
However, a trailing stop might not be the best way to exit a short-term trade
with a trading horizon of around three to ten days. All trades need a little wiggle
room, or leeway, to cope with the typical amount of noise in the market: Because
you have no idea how much leeway each specific trade will need, the best you can
do is estimate an average leeway that seems to work best for a large group of trades
and within each trade. We will do this shortly for our systems.
For example, a trade with a profit target at 5 percent and stop loss at 1 per-
cent (no trailing stop) has an average wiggle room of 6 percent no matter how long
it lasts. If you use the same wiggle room for all trades, the average wiggle room for
all trades is also 6 percent. If you substitute the stop loss with a trailing stop, then
the wiggle room within an individual trade that shows a profit will become small-
er with time, and sometimes the wiggle room will become too small and have you
stopped out of trades just moments before the market is about to take off in your
direction. If you work with a profit target, you might also have to place the target
closer to the entry price if you work with a trailing stop than you would had you
only worked with a stop loss. Because of the large wiggle room, some profitable
trades that would have remained open if a fixed stop loss were used—and therefore
might have ultimately reached the profit target—will instead be stopped out by the
trailing stop. To increase the number of target hits when using a trailing stop, the
target needs to be placed closer to the entry. This limits the profit potential even fur-
ther when compared to the stop-loss version of the system, but increases the profit
potential for the trailing-stop version (when examined by itself), because more
trades will be exited at a maximum profit instead of a trailing stop.
But that isn’t all. To keep the average wiggle room constant over time, both
within an individual winning trade and all trades (both winners and losers), the
wiggle room also needs to be slightly larger at the beginning of a trade with a trail-
ing stop than it needs to be for a trade with only a stop loss.CHAPTER 18 Exits 203