How To Exit With Profits

Okay, you've placed a position in the market and you're making money. Alright, when do you decide to take your profits? Here's an example of a simple strategy to help you decide when you should exit your position.

To illustrate, if you're 'long' and the market hits a 21-day low, you exit. If you're 'short' and the market makes a new 21-day high, you exit. This stop is recalculated each day and it is always moved in your favor so as to reduce risk or increase your profits. This exit strategy produces above-average profits when traded with sufficient money.

Be aware that this exit strategy can far and away make you more money than the buy-and-hold approach. Drawdowns can be significant using this approach; however, position sizing and diversity can significantly reduce drawdowns.

Forget About Buying and Holding

The strategy of buying stock when the price crossed above the 1-year average and selling it when it crossed below that average outperformed a buy-and-hold strategy by a large margin.

An Excellent Stock Market Entry Point

I want to emphasize that this entry point COULD make you rich. The reason it could make you rich is because it's a great entry point system; however, making money in the stock market is much more than 'entry points'. Position sizing and money management are larger aspects to making money in the market. What does an entry point not tell us?

• How do you protect your capital when the market moves against you?
  
• How much do you buy or sell when you get a signal, etc. etc.

You see, real money is made through intelligent exits - which allows a trader to cut losses short and let profits run. In the future I will discuss some exit strategies that you can adopt. However, all good traders have realized that money is made by developing their own ideas and following a method that is designed to fit them.

Donchian was one of the first people to write about a system using moving averages. He used both the 5-day and 20-day moving averages. When the 5-day average crossed above the 20-day average, you went long. When the 5-day average went down and crossed below the 20-day average, you reversed and went short.

This type of system works great in pure trending environments; however, markets tend to trend about 15% of the time. As a result, during consolidation periods this system gets whipsawed continually.

To overcome this problem, R.C. Allen popularized a method in the early 70s using the 4-, 9-, and 18-day moving averages. When the 4-day and 9-day averages both crossed the 18-day average, you would enter the market - long if they are moving up and short if they are moving down. When the 4-day signal crosses back across the 9, you get an exit signal. However, you don't get a new entry signal until both the 4 and the 9 are on the same side of the 18-day average.