a point when the risk outweighs the diminishing reward for being in the trade. That
is when you should exit and ready yourself to trade the next event. Most of my
research on the NASDAQ stocks indicates an optimal maximum trade length of
five to nine days, depending on the entry technique.
Working with end-of-event exits also seems to produce the best results
together with breakout-type entries. This is pretty obvious, because breakouts are
the type of patterns most likely associated with some type of news fueling the mar-
ket and creating the swift move needed to create the breakout. Swing trading pat-
terns also can work well with an end-of-event stop. Usually, however, the swing is
a pattern that forms in several stages, with the final stage occurring some time
after the news first hit the market, which means the trade will usually be triggered
one or two bars after the breakout trade. This is not a watertight rule, however, and
sometimes the swing will trigger the trade before the breakout does—especially if
the market is anticipating something in the works for the stock in question.
Measuring the end of an event in units of time isn’t the only way to do it.
Another way is to measure how much the market is likely to move after a certain
entry is triggered. For this to work, you need to have researched how far the mar-
ket is likely to move, on average, after an entry signal is hit. With this information
at hand, you can place a profit target this distance (and sometimes plus one or two
standard deviations) away from the entry. If and when this profit target is hit, you
know the market has done a better than average job of discounting the news that
fueled the move, and you can exit with a decent profit before the market realizes
it has done too good a job and starts to fall back to its starting level. Using this
logic, the end-of-event exit also functions as a profit target.
Many might argue that the above scenario is instead a good opportunity to
add to the trade. That might be so, and I haven’t extensively researched that possi-
bility. The way I see it, however, is that the later in a move you enter into a trade,
or if you scale in, the greater the chance that that last entry will result in a loss.
Better, I think, to exit with a decent profit and prepare yourself for the next signal
with the same odds for success as the first one, in either the same or any other
market. Why tie up capital in a trade with ever decreasing odds for a continuous
profitable development? This conveniently brings us to the next reason to exit a
trade.Money Better Used Elsewhere
What do we do when nothing happens? We have just entered the market, and the
trade is going nowhere. This is an especially important question for those of us
whose funds are limited. Maybe our entire capital is tied up in one or more trades
like this and, as long as it is, we’re really not monitoring the market for other trad-
ing opportunities. Thus, even though this specific trade is going nowhere, it is still
costing us money because it keeps us from entering into other trades. Where, how,CHAPTER 18 Exits 205