Every trader and investor knows the frustration of missing a trade or the anxiety they feel when in a trade. It is very difficult to pull the trigger after a series of losing trades. What can be more difficult is not knowing what to do once you are in the trade. How long should you hold onto the position? Where do you place stops? Do you even need stops? When should you exit the position? In this chapter, we are going to look at the importance of having a good exit strategy and knowing how and when to exit a market. This is of vital importance because it is only when you exit a position that you determine your profit or loss.

Although this seems basic, indeed it is not. We will look at various technical and nontechnical ways to exit a market. Keep in mind it is very easy to enter the market; you simply pick up the phone and buy or sell. Exiting is the hard part because trade management comes into play. You also are dealing with the emotional ups and downs of your position either making or losing money. There are many different types of exit orders and ways to place your stops; each one has its own special purpose.

The value of Stops

Once you are in a trade and, more important, before entering a trade, you should place a stop in the market. Some people use mental stops; however, you need to have great discipline to adhere to your mental stops once they are hit. It becomes too easy to wait and hope that the market moves back in your direction. I would strongly recommend placing your stop with your broker. Placing stops will minimize your losses, help to ensure profits, and reduce risk. Stops should be placed in an area that, if hit, will prove your analysis wrong. Remember you got into a position for a reason. There needs to be a point where your reason is no longer valid-this is where the stop comes in. If you feel that the market is going lower, to what point must the market move for your analysis to be considered wrong. For example, I feel the market will move lower, but if price is rising and a certain price is hit then the market wants to go higher and I am wrong (see Figure 6.1).

Exiting a Market

Joseph Luisi

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The Dollar Stop

This is the most basic and simple approach to stop placement. You simply figure out the maximum dollar amount that you are willing to lose (risk) on that particular trade. You may have a $20,000 account ready to trade the S&P 500. You can decide that $500 is the most that you are willing to lose per trade. This will represent 1 point in the S&P. Therefore every time you enter the market you add or subtract one point and place your stops accordingly. You want to make sure that the dollar loss gives enough room for the trade to work. If this stop is too tight, many potential winning trades will be stopped out before they have a chance to work out. With the S&P 500, a $ 100 stop is too tight and you will be stopped out too often for your trades to work out.

On the other hand, you want to make sure that the amount you are willing to risk is not so large that your capital base is depleted if you encounter a series of losing trades. In our example, a $1,000 stop would be too wide. Five losses in a row will reduce your capital by 25 percent and that is too high. There is no right answer; you just need to use common sense, look at the market you are trading, and choose an appropriate level.

More volatile times call for a wider stop and quiet (less volatile) times a tighter stop. You will also want to determine from what value the stop will be calculated. Will

Figure 6.1 Place a stop below the market to protect a long position.

Figure 6.2 Placing a stop to limit risk to exactly $500.

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it be from the entry price? Or from the previous days high or low? In Figure 6.2, determine your maximum dollar loss for the trade before establishing your position. With the Deutsche mark, we will use 0.40 tick, which represents $500. Once the stop is placed, we wait for the trade to work out. The benefit of using a dollar stop is you can determine how many times you can be wrong before pulling the plug. A $10,000 account using a $500 stop can have 10 losing trades in a row and still have 50 percent of the capital remaining.

Breakeven stops

This technique is more for trade management than for initial placement. This is by far one of the most important stops. The importance of this stop is preservation! When a trade moves in your anticipated direction by a certain amount, you should immediately bring your initial stop to breakeven. The breakeven level is your entry price. Remember the initial stop is the one you placed when you first entered the trade. With the breakeven stop in place, you will be able to relax and let the trade work its course knowing the worst possible outcome is that you will lose only commissions.