Let Your Profits Run...

Submitted by Markus on Fri, 10/17/2008 - 15:54.

In our Simple Day Trading Strategy I use a stop loss and a profit target based on the volatility of the markets. This means that I am using a larger stop loss and profit target in more volatile markets and a smaller stop loss and profit target in quiet markets.

This morning I received an email from a trader asking me:

"Why do you use profit targets? I heard that you should let your profits run."

Using a profit target will help you controlling your emotions. Just think about it: When you exit a trade, it is usually too early or too late. You won't be able to pick tops and bottoms, at least not consistently.

So if you get out too early and you see that the market continues to move in your direction, you might be tempted to re-enter. You might get angry at yourself for getting our too early and want revenge. So you enter again, but it's too late and the trend is already exhausted. As soon as you enter prices move against you and you might realize a loss.

Getting out too late can also trigger certain emotions. Let's assume you were right about the direction of the market and saw $500 in profits. You haven't taken any, since you want to let your profits run and now the market retraces and your unrealized profits decrease to $400.

You now say to yourself: "That's a normal retracement. The market will continue in my direction shortly".

But it doesn't. Your unrealized profits shrink to $300, and now you have a plan: "As soon as the market recovers and I see $500 in profits again, I exit". And it really happens: The market bounces back and you see $400 in unrealized profits. But then the market retraces again, and your profits shrink to $200. You wonder if this is a "normal" retracement or if the trend is exhausted. At this point you are uncertain when you exit, and this indecision paralyses you. You sit and wait, hoping that the market moves again in your direction.

But it never happens. Prices are now hovering around your entry price, but since you've already seen $500 in (unrealized) profits, you now don't want to exit at break-even. You say to yourself: "The market will come back, the trend looks still strong", and you start justifying your position. You are desperately looking for clues that the market will continue to move in the right direction and you might plot more indicators on the chart or even change to a different time frame.

With all these additional information you know feel more confident that this is only a retracement, and that the market will bounce back shortly. But there's still some doubt, and you decide to take profits as soon as you see $250 in unrealized profits. You are so focused on "being right" that you don't realize that you are fooling yourself.

And the market continues to go against you.

So instead of getting out of this trade you look at more indicators, more timeframes, more information.... and let a winning trade turn into a losing trade.

Don't let THIS happen to you!

Use a profit target and a stop loss and put the trade on autopilot. And if the market moves beyond your profit target, don't bother! Be happy and contend with your profits. After all, you realized profits.

The key to trading success is to be right about the direction of the market ... and then realize the profits. Paper-profits are not worth anything. Take your money off the table as long as it is there!

Have you ever experienced such a situation? - Leave your comments.

Let your profit run

Submitted by Anonymous on Sat, 10/18/2008 - 19:13.

Markus is right.

It is amazing how we go trought exactly the same emotions. Even if we are from different parts of the world. Should the statement say: Take the profit and run...instead?

All kinds of ways to beat the market ..

Submitted by Anonymous on Mon, 10/20/2008 - 01:24.

I am in agreement with Markus on making profits should be your main goal as a trader. At some point in the future, as your account grows. I believe swinging for the fences can be a strategy that you can employ especially in extraordinary moving markets with extreme movement.

For example, if you are trading 2 contracts, going for your profit target and allowing the second "to run" is a valid strategy that I use profitably, and more importantly keeps me from overtrading and trying to get back in a move.

Rockwell teaches about ADR and they use to teach about a Greenline Aggressive strategy. If you like to swing for the fence every so often, then ask them how to do it profitably.

David AKA Tiger

Re: Let Your Profit Run .....

Submitted by Anonymous on Sat, 10/25/2008 - 01:03.

I could not say it any better than Markus's reply. Not only is he 100 percent on target but I have lived that very losing scenario over and over until being taught better. Greed will lose almost every time in this case....

What about trailing stop losses?

Submitted by Anonymous on Sun, 10/26/2008 - 13:44.

Seems my previous comment was lost somehow, but if it shows up after I post this, then my apologies.

I was wondering, whether it wouldn't be even better to use a system that supports the use of trailing stop losses, so you can then use such a trailing stop loss (which you also calculate the size of beforehand) to put the trade on auto-pilot as it were? After all, then you'd *really* let your "profit run" until the market basically tells you that the trend has run out of steam? And you'd still remove the discretionary/emotional part of the equation, which I agree is very important.

About Trailing Stops

Submitted by Markus on Mon, 10/27/2008 - 13:57.

Yes, trailing stops are used by many traders.

Whether you use profit targets and stop losses or trailing stops depends on your personality and comfort level. Here's the main difference:

When using a profit target, you get out of the market at your pre-defined profit. Therefore it is easy to calculate the Risk/Reward Ratio: If you are taking $2 off the table for each $1 that you risk, then your Risk/Reward Ratio is 2. Van Tharp calls this "Multiple R", and this ris/reward ratio is often used when calculating the optimal position size.

When using a trailing stop, you never know what the Risk/Reward Ratio will be. You can use historical data and make a "best guess", but you'll only know the exact figure when you exit the trade. Depening on your money management and position sizing approach this could cause problems.

In addition, there's a psychological problem: Let's say you are using a trailing stop of $500. If the market moves in your favor by $1,000, and you get stopped out with a $500 profit using a trailing stop, then you left $500 on the table. So you already saw $1,000 in profits before finally realizing $500. Many traders have a problem with that: Once they saw the trade moving $1,000 in their direction, they might get mad if they "only" realized $500 out of this move.

Again, trailing stops are a great concept IF it fits your personality and into your trading plan.

how about doing both?

Submitted by Anonymous on Tue, 11/11/2008 - 00:17.

I totally agree with the concept of bracket trading...knowing your R factor and trading that as your plan overall. But , if you are trading multiple contracts and you want to take advantage of the occasional extended move in the market, you could take your money off the table at your regular profit target and leave one or two contracts on the trade with a trailing stop. This way you have a chance to participate in the large move that may occur, but if not, your stop will preserve some of the profit on that last contract set. This obviously needs to be backtested to see how well it works compared to the regular strategy...but it seems like it might make a good addition to your plan.

This sounds like a good

Submitted by Jason Wingfield on Sun, 11/23/2008 - 07:37.

This sounds like a good idea, especially if you tighten the stop to break even on your second contract as you let it run. However, if the second contract is stopped out your profit is 1.0 * profit target, while a full losing trade is still 2 * stop loss. Unless your strategy produces a very good percentage of winners with the second contract this is a losing proposition.

As an alternative I have been considering managing the second contract as follows:

- Take profits for first contract when initial profit target reached.

- When the initial profit objective is reached, tighten the stop to break even and reset the profit target to 2 * initial profit target for the second contract.

- If the second contract reaches the new profit target, tighten the stop to the last profit target and reset the profit objective. Continue until you are stopped out or decide to close your position and take profits based on other trend indicators.

This could work in theory during a strong trend and would lock in profits along the way, but still allow the trade room so that it doesn`t get stopped out as easily as using a trailing stop. My preference would be to do this on say, YM after MC or ES (or both) have already reached their profit objective and closed out. Then you have nothing to lose following the second YM contract to maximize the profits.

Of course, this requires testing too and I`ll be trying it for the odd trade when the trend looks strong.