The 800-Pound Gorilla in the Room: Exits

AdamAdam Grimes's blogs, General Comments, Trader Development, Trading Psychology17 Comments

This post is motivated by two things: One, I have had virtually the same conversation with several of my mentees over the past month and also with a few of the other traders on the desk, and so I think I may have identified something that is affecting a lot of people. Two, I have identified this factor as the main reason I underperformed last month in my own trading, and I intend to make major corrections in this area in the coming month. Actually, I guess there is also a third reason, which that no one else seems to talk about this subject very much.


Technical traders devote most of their attention to figuring out where and when to get into the market. Most training focuses on “setups” or trade entry conditions, and, in fact, it’s not uncommon to find someone who has been trading less than a year who knows 20 legitimate ways to get into the market. Most indicators, systems, and statistical analyses (mine included) focus on defining an edge by the entry condition. If you think about this, there’s a good reason for this—it is difficult to make money if you’re not buying before the market goes up or shorting before it goes down (on average)! However, entry conditions alone do not make a trader profitable. Here is the secret that it seems no one is talking about: where you get out of the market is at least as important, and maybe more so, than where you get in. Exits are as important as entries.

There are two broad categories of exits:  exits at a loss and exits for profit. For most traders, exits for losing trades are not that much of a problem. You put your stop in at your initial risk point, and, if it’s hit, you’re out of the trade. Clean and simple. I think maybe the reason that most traders are so good at this is that the market very quickly eliminates those who are not. If you’re one of those traders who likes to cancel stop orders, move them further away to give it “a little more room”, or even add to losing trades, you will probably have a short, but very interesting, trading career. Most traders who stay in the game for any length of time are pretty good at getting out of losing trades, but winning trades present a much more complicated set of problems.

There’s a weird psychological problem that hurts many more traders than we realize. For instance, let’s say you enter a long day trade in a $50 stock with a .40 stop, and you see a clear profit target a full point higher. Now, you enter the trade and it immediately ticks against you. What if it trades to .38 against you, within .02 of your stop? Few traders have an issue with this because most can accept that this may just be a losing trade, take the loss, and move on. But now imagine, having been within .02 of your stop, the stock reverses and heads higher back to the entry price—and now you’re .20 in the money where it stalls again. Now, .20 in the money on this trade is really nothing because you were risking twice that, but many traders will be tempted to take the profit here. You know this is normal fluctuation, that it may go .20 in your favor and pull back almost to the entry price before heading higher, but few traders are going to be in this trade because most of them already booked the profit. You can never go broke taking profits, as the old saying goes. The problem is, this particular old saying is bullsh*t (apologies to Penn and Teller).

There is some weird psychological process at work here. Actually, maybe it’s not that weird: it’s called “wanting to be right”. For many traders, being right is more important than making money. In that scenario I described, when you book the .05 profit, knowing that it’s nothing, some little voice in the back of your head says, “let’s just hit the bids and we can make another mark in our winning trades column.” It is possible to be very profitable with a win ratio of well under 50%, but we’re all human and we all like to be right. Be careful of focusing too much on your win ratio. (More on this in a future blog.)

Just something to think about this month and maybe it can be a growing edge for many of our readers. The nice thing about identifying a pretty glaring weakness is that it is also an opportunity, as work done here can pay off quickly in terms of your bottom line. Monitor your mental and emotional state and see how you are handling fluctuations in winning trades compared to losing trades, and make sure that you aren’t getting out of good trades just because you want to be right. (Note that there can be legitimate reasons for getting out at a small win or small loss, but what I was talking about here was when we manufacture nonsense reasons to justify getting out of perfectly good trades.)

Here’s hoping everyone has a good November!

17 Comments on “The 800-Pound Gorilla in the Room: Exits”

  1. This article really hits home with me. I tend to do ok getting into the trade but getting out when its right kills me. Overcoming fear and greed, I think, is at least 50% of trading. Two very powerful emotions that aren’t easy for me to ignore. When I watch Steve Spencer trade live on Stocktwits he seems so emotionless. Almost robot like. His trading behavior really inspires me.
    Ego and the need to be right play a huge part in this game aswell. I often read comments from people who feel the market is wrong and not them (Yahoo message boards). Luckily I’ve been humbled enough by the trading gods to believe this isn’t true. The market is ALWAYS right. Great article.

  2. This article also hits home for me too. And I also have Steve Spencer image in my mind when trading – and I nicknamed him T-100 – like that robot from the Terminator II which has no emotion and kills/crushes everything that stands in his way and..most importantly..he has the ability to take any form if that is what it needs for him to get close to the target. Well, Bella is more of the James Bond type – sometimes it looks like he has a heart. Sorry for these comments, I wanted to be funny 🙂
    Getting back to the article – this poses a big problem and this is the cause for which I underperform – the exits. Of course, I see Steve on stocktwits taking a short in FCX and staying in an 80c rebound – but this doesen’t mean that he didn’t unload some size on the initial move. I guess on important thing is to have the proper size when you enter the position as to unload it at certain price levels and also keep a core one for when the stock reaches your final price target. And how do I enter the proper size at that particular level? Add after 40c only to see it coming down below my average and execute my SL (I love X)?

  3. Which James Bond Sean Connery Roger Moore or Daniel Craig? Thxs for taking the time to be so funny above and contribute to our learning process. Bella

  4. I agree that exits are important. An epiphany came to me when I realized that edge can not be defined by entry alone. The entry and exit form a union that will define the profit or loss. It is not possible to define an “entry edge” without also defining the exit that goes with it. Exits are made difficult in that the optimal holding period will be dependent on market conditions and will vary. More importantly, due to the wave nature of the market microscopic variations in either exit price or holding period can result in large differences in realized profit or loss. In terms of learning what works, i.e taking fast profits or holding for longer profits, tracking multiple strategies with different accounts could prove useful.

  5. Adam, thanks for sharing. Loss aversion – not uncommon even with primates – is one of my biggest obstacles. What I am doing is this: I shut down all P&L considerations. And I am carefully aware for for any monetary thoughts during my trading. If I feel I have to leave a trade and I see my mind wandering to my P&L I know I have to stay in if the conditions for the trade have not changed.


  6. 🙂 I thought you are more close to the ‘James Bond’ idea: sharp minded, good looking (can I send my CV to SMB? :)) ), always ready to say a good joke and on the other hand he has the eyes in all corners and is ready to shoot if anyone suspect (stocks in play) is making a move – and, of course he doesen’t miss.
    And if it is to chose an actor that will be: Sean Connery.
    Thank you for your reply 🙂

  7. Another thought. Maybe we can consider this as time inconsistency problem. When we enter the trade, we expected the price fluctuation. The realized outcome that the price went down biased us to believe that we could be wrong, which make us forget or block our previous belief that it could be just temporary fluctuation. Thus when price goes up again, we eager to correct our mistake or reduce loss. That may be another reason why discipline to stick to a plan is so important because sticking to the plan prevents the time inconsistency.

  8. That’s the problem with the “fifteen subsets” of trades that Bella goes on about. How can you not exit early when you are supposed to be able to identify that the trade is one of 15 subset types? I agree with the trader that said that this is too complicated. I believe simplifying helps more than complicating. Maybe Bella is smart enough to identify which subset number a trade is during a live market, or maybe he just thinks he is. Your excellent posts on randomness suggest otherwise. There is a lot of “thinking” that is necessary to try to ID which subset it is during a trade. This provides reasons to get out or worse yet causes “deer in the headlights” reaction. Simplier is better IMHO.

  9. Am I getting called out on my own blog here? Seems like you are working on your trading with thought and finding plays that make sense to you. I believe “Bella” would be a big fan of that 🙂

  10. Marty,

    A couple thoughts. First, I agree that simple is better in almost every respect. I have made a big effort to simplify my daytrading and the results have been promising. However, I should qualify by pointing out that this “experiment” hasn’t been underway long enough for me to really make any firm statements.

    While I constantly work to simply my own trading, I do think there is an important point about SMB’s (and Bella’s) focus on subsets you should consider:

    An experienced trader operates somewhere between analysis and intuition. There is quite a bit of active analytical thought, but there is also a sense of “just knowing” at times. I firmly believe there is no magic to intuition; it is merely the result of long exposure and seeing tens of thousands of patterns, so the mind assimilates the patterns and processes them somewhere under the level of conscious thought. Because of this, teaching people to think with the thought process of an experienced trader is a daunting task. Our focus on subsets of trades is one good way to do that. Is Bella thinking through the 15 possible subsets while he’s in a trade? No, because his mind already narrowed the field down to the 2 or 3 he needs to actively consider at any time, but if something changes he will quickly shift focus to the 2 or 3 other subsets that apply.

    When you achieve a level of mastery over the material, active thinking recedes. Intuition takes its place as the partner of active analysis, but the problem is how to bridge the gap between novice and master trader. Focusing on everything that can happen in a trade (i.e. subsets) is one tool that helps.

  11. It is quite easy to say “make sure that you are’nt getting out of good trades just because you want to be right”. But take the example given in this post. How do you know that a trade which has gone so close to hitting your stop just reversed and showed a meager profit and now on the pullback is going to make further profit or loss? It is quite possible that it will this time move down and hit your stop. If that happens, you will be cursing yourself because market had earlier warned you (by moving pretty close to hitting your stop) that the trade was not good and still you survived and had an opportunity to get out at least at breakeven and preserve your capital but you did not heed to this warning and stubbornly stayed with the trade only to see your stop being hit on the second time. Will it not be more damaging psychologically? If one is right on the trade, then it will move in to profit immediately. If it goes against so close to the extent of hitting the stop, then something must be obviously wrong with the analysis. Is it not? It is better to be sitting out wishing to be in the trade rather than in wishing to be out.

  12. Hi John,

    I would take issue with the basic premise of your question: “If one is right on the trade, then it will move in to profit immediately. If it goes against so close to the extent of hitting the stop, then something must be obviously wrong with the analysis. Is it not?” This is true of certain kinds of trades, but there are also many trades that may well take time and fluctuate before they move. I put my stops at a point where, if the market goes there, the trade is wrong. The market going close to that point is not any kind of warning… it’s just random noise in most cases.

    And, respectfully, I think you may be missing an important side of the argument. You cannot be cursing yourself if the trade is close to the stop, becomes slightly profitable, and then is stopped out. That is fine. If you get out every time, you will exclude yourself from the time the trade goes and you make 20 times what you were risking on it… and that could be the trade that makes your week, month or even year depending on how you trade. Think of this over a sample of 1000 trades and don’t make any one trade a personal experience. I think that’s probably the key to this.

    On the other hand, if you’re a momentum trader, that’s a different kind of thing… but then you still have issues of how much to give back and potentially getting out of large moves too early. You just have to have a plan and it has to be a profitable plan.

  13. Thanks for your reply Adam.

    It depends how great a “master trader” is. If he is killing it everyday and consistantly guesses correctly which subset it is, then I would totally agree with you. I have no idea how great Bella trades or not, I’m just speaking from my knowledge of the markets. Your posts on randomness were excellent and spesk to my point that consistantly guessing the subset may not be possible for anyone. If this is the case, then that would be very good to know and then work on simplification of the decision making process in such a way that we maximize the probability of extracting the most profit from a trade — without knowing the subset.

    I agree that there are somthings we can assume, like how much a stock will trade beyond its’ ATR, etc, and those should be kept in mind. But your article describes the trader thinking it is one subset and then discovering that it is another, thus missing out on profit. I don’t want to believe I can know something when the reality is, I can’t know it. I don’t “know” if I can know it or not, but more and more I supect I can’t. Your randomnees posts speak to this.

  14. Bella, I’m mot trying to “call you out”, LOL. I’m just trying to deepen the intelligent discourse in the fascinating subject of trading that you have going in this great blog. As you have said repeatedly, the markets have changed, and approaches that were possible in the past may not be anymore. I am questioning the wisdom of expending our finite energy resources on trying to discern subsets in live markets because I question if it is possible for anyone. Adam’s excellent posts on randomness deepened my skepticism. If it is not possible then that could be a very profitable revelation, as we can expend our energy in other ways to facilitate the decision making process. This might in fact serve to sharpen our intuition, as we are focusing on more pertenent things.

    Either I am wrong, or right, meaning either we can know what subset a trade is before it happens or not. I am not certain what the answer is, but I can see the danger of believing you know when you don’t — tons of ways to miss out on profits and lose money. On the other hand a system could be developed where you have strategically placed profit targets and stops and just letting the trade play out in any surprising way it wants to. Like Adam said, it may miss your stop by 2 cents and be a huge winner. Trying to discern what the subset “is” is going to take the vast majority of traders out of the trade early, as they watch it run in their direction IMO. This happens because they give themselves the power to hit the eject button based on what subset they believe the trade is. With the algos out there, things are very often decieving.

  15. Another thought may be too obvious to even mention it here. One way to tackle this problem is just to make a more detailed plan next time that specifies what we should do in this situation. Or visualize what could happen next time and make a corresponding plan. Since I am not trader yet, I guess that I can raise some potentially obvious questions. If that’s the case, I am sorry.

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