Today, my friend bittered how he chickened out and exited a profitable trade too early.
As a short term trader, how far can we let profits run?
If we keep a tight stop, and we let profits run, we risk losing part or all of our profits if the market pulls back quickly, or take out our trailing stop, and then go on with its original run – a common frustration.
Therefore a lot depends on how tolerant our short term stops are. Our stop tolerances are in turn dependent on the reward risk ratio and money management strategy associated with the setup and its edge, (and whether the edge is still there). How far we let profits run, depends on these and the potential for further trending or breakout profits. There is one more factor to consider – but we shall leave that till the last paragraph.
Take for example, a breakout trade around the European session opening for the EUR/USD. Generally, the market insiders tend to take out stops on both sides of the range before proceeding with one stronger trend direction. (Remember this is not necessarily true everyday, – the market will do whatever it wants to do.) If we see a nice set up for the first breakout and take the trade, watches it reach our expected reward risk ratio – how far do we let profits run thereafter – do we even consider letting profits run? The answer is simple – do we still have an edge under the circumstance? If we are dependent on HOPE that momentum will carry on, we have better find a way to track that momentum or keep a tight exit stop – the whipsaw back into range can be nasty and fast.
If we are unable to track momentum, and our set up is completed, we can say our edge is gone. Any ability to let profits run is dependent on how much we have exceeded the expected reward risk ratio, and the potential that price continues to trend beyond our expectation. The run may be due to further stop catching, position building or unexpected market news – all of which we have no certainty or information on.
Based on the same example, if price action has weakened but subsequently resurfaced with strength, there may be some traders who would exit partial positions and leave partial contracts to let profits run. I will only do that if my partial exit(s) can give me a monetary return that is the same as what I would get if I had exited fully at set up completion. Then I will set the remaining positions at a breakeven stop if I cannot find a way to monitor momentum. If I do not exit partially, my trailing stop for the full position is at that price level which realises my initial reward risk ratio. Can I get swung out easily? Yes, but unless we know our edge, there is no point in taking on potential risks beyond our targetted reward risk ratio. We can always re-enter with another set up, or we may just have to give this up – remember there are plenty of opportunities down the road. Some of these opportunities allow us to let profits run extensively, and some do not.
If however the trader insists on taking all such opportunities when they occur on a full trading position, it is best he first considers how to manage the trade, what potential reduction in reward risk ratio he is prepared to accept, the longer term impact on his equity based on continual deployment of this strategy, before he enters the trade.
Remember, there are essentially 2 types of profit runs
1. Price persists in a favorable direction even after the set up has been completed and achieved our desired reward:risk ratio, and we do not have an edge.
2. The set up deployed is meant to capture continual price trending action, and remains relevant when price persists in a favorable direction even after the targetted reward risk ratio has been achieved. The edge continues to be in play.
The example discussed falls in the 1st category. In the 2nd category, the set ups meant to capture and follow trending prices will indicate when to exit the trading positions, regardless whether the target reward risk ratios have been achieved. When the edge is gone, the trader exits fully. Such set ups generally let profits run, but are never foolproof. Such set ups are also price movement oriented, not price level oriented.
The last but not least consideration is the trader’s psyche makeup. If his personality is such that he is less anxious with small ebbing retracements, but freaks out at a large swift pullback, then it is better he keeps a tight stop loss as profits run – otherwise he risks taking foolish action without properly evaluating his options when a big retracement wave hits.