Recently I had the opportunity to take a couple of flights and as always, that was one of the pre-takeoff instructions from the flight attendant. I thought, “Wow, that’s what I tell people when I’m discussing trading rules!” And a new installment was born. For some reason, locating the nearest exit on the plane is something I’ve done since before they began that instruction. In fact, I actually count the rows so if the lights are out, I don’t need to think about it at the most inopportune time. I’m bringing this up because exiting is often the last thing people think about when trading, and when it does come time to exit, you usually wish you were better prepared. This is not only for losses, but for profits as well. Have a plan.
It’s been written in many places that people involved in fantasy sports leagues spend more time on their team draft than they do on their investments. More time on the less important of two disciplines. Sounds ass-backwards to me. Unfortunately, an ass-backwards approach is what I believe drives most trading as well. So much time is spent on the entry, we have little inclination to spend much time or effort on the exit…“I’ll worry about that later.” I personally believe, and teach, that this is the approach that often leads to the wrong outcome. Profits turn into losses, or losses into bigger losses. This is not something I’ve seen in just newbies, but experienced traders as well. It is entirely possible I’m the one that has it backwards, but I’ll explain my reasoning.
As it’s not a profit or loss until the exit, I espouse spending around 20% of your time and effort on entries and 80% on the exit; and plan that exit in advance. Just like on the plane. Now granted, the plane exit thing is an extremely rare event…thankfully. That’s ok. Still have a plan. Because before you trade, just like before takeoff, your thought process is much more rational than when you have “skin in the game.” Getting out of losers is painful, we all hate taking losses. Getting out of winners is never easy. We don’t want to get out too early and watch it go further, we don’t want to get out too late and look back with 20/20 hindsight wishing we had gotten out sooner.
Planning ahead without our money on the table yet is what I believe leads to consistent results. This isn’t even to say that you need to make money on most of your trades. But if you plan correctly in advance you can still make money overall. I’ve been told, “I want a system that has 70% winners.” This is one approach. But if those losers are consistently 3 times as large as the winners you lose money overall. If you only win 3 out of 10, but the winners are 3x the losers…well you get the math. A lot to think about when you’re in the middle of it all.
The S&P 500 reached a peak in early 2015. Before the end of August, it was down just under 10%. In technical analysis, 10% is a healthy correction. Add to your position, if you’re so inclined. Establish a new long position if you’ve got none on at the moment. But while we were approaching the 9.54% bottom, that’s not what was in the news or on many people’s minds. The attitude was the new bear market is upon us. Why? Because people were long and now losing money or at best, giving back hard earned profits. The last thing being discussed by the majority of news outlets was this is actually very healthy for the market. If you brought up the idea of just a correction, which I did (I have witnesses…or it didn’t happen), people thought you had no idea what you were talking about, or it was wishful thinking. The index declined even further in February 2016 after an intermediate rally, and the bear market talk was even louder. Understand, the accepted definition of a bear market is 20%, not even close! If you get out quickly to lessen your pain and ‘it’ goes up again, you can always get back in, commissions are pennies/share.
If you were long the S&P, or your specific securities were going through a similar correction, it was probably painful. You didn’t get long at zero. So your personal pain level was higher. You were not thinking rationally about your positions at that point. You were very likely driven by emotion. Never a good idea in trading. And here’s where planning ahead comes in. I’m not condoning any specific approach. You may trade with profit targets. You may trade with trailing profit “stops,” accepting in advance you’ll never get out at the top. You should ALWAYS be trading with “stop-losses” either entered when you get into the position as a good till cancel order, or as a mental stop, as long as you will remember and listen to it at the time. You may average your position and buy more. All of these approaches can and do work. Just like profits on 70% of your trades, 30% of your trades, or somewhere in between can and do work. As long as it’s part of the overall plan.
Remember, when you get on the plane, you have multiple possible outcomes. The most likely is to get off at your intended destination, hopefully near your intended time. If the *#%@ hits the fan, you’ve planned your exit. And if it’s somewhere in between, like they lose your luggage, it never hurts to have a backup plan for that either. No matter what, always have a plan in advance. It leads to more profits. It leads to less pain. And whatever the plan, Stick To It. I promise, you’ll sleep better.