Trading systems with multiple exits
When we create a trading system, the entry usually takes only a few lines of program code, but the exit strategy and its code are often very complex. We can have a system with one very simple entry and a dozen, if not more, exit strategies. The reason it takes so much effort and attention to get the most correct exit is because years of stock trading experience have shown how difficult it is to create a truly accurate and correct exit from the trade.
Creating an input signal is simple. Before we enter any trade, we know exactly what must happen to get a signal, and if market conditions coincide with the rules of our system, we will get the right entry signal. Entries are easy because we are able to set all the conditions for them in advance and the market has to come in line with those conditions, otherwise the trade simply won't be made. When we are in the market with an open position, the number of possible scenarios of what can happen to our position is infinite.
It would be extremely naive to hope for effective returns in all trading situations with only one or two simple exit strategies. Nevertheless, there are still many popular trading systemsIn which a simple "reversal" of the input rules is a signal for an output.
We believe that good exits require an enormous amount of work on their content, and that simple single exits are nowhere near as effective as a series of well-planned exits, in which there are many possible outcomes. Our exit strategies solve a series of specific problems.
We want to protect our capital against any catastrophic losses, so we need Stop out based on MM (Money Management Stop)We want to use a stop loss that limits our losses, but does not trigger too early if the market is "drawing a sawtooth". Once the position has started to make a profit we want to move the stop out closer, so that the risk to our capital is reduced or eliminated altogether. As soon as it becomes possible, we set "Breakeven Stop" (lossless stop-out)so that our profitable trade can no longer turn into a losing one.
In most of our systems, the main goal is to maximize our profits in every transactionIt's not about taking any small profit as soon as we see it. Protecting some of the small profits that appear in an open position should leave us with the possibility of making larger profits. If prices moved in our favor every day, the exit could be greatly simplified.
However, such price movements are impossible on the real market. Day after day we have some fluctuations in prices in one direction or another. In order to facilitate our task of maximizing profits in each trade, in some cases we can solve shift our output depending on the movement of current prices to avoid a premature stoppage of the transaction.
This highly efficient exit is based on measuring the amplitude of the price movement from the previous day's closing price. For example, we may want to exit immediately if an adverse price movement reached 1.5 ATR from the previous close. The minus of this, based on volatility The reason for this is that it shifts smoothly enough, so as a result of a series of unfavorable days, when prices moved against us, our volatile the trigger may never work if the 1.5 ATR condition is not met on any of the days. Therefore, it is obvious that this output, can not be used as the only limiter of our possible losses.
When to fix the profit from the transaction
So, we have a MM stop-out to protect against large losses, we have a "Break-Even Stop" (stop-out on breakeven level), have an exit signal at a sudden trend reversal, but we still decided the question of when to fix profit from the trade.
We make trades for big profits, and the bigger the profits appear, the more of them we want to protect. This strategy is called multiple "Profit-Taking" outputs. If we have 1,000 profit we can protect 50% from it and agree to lose 500 of our current profit in case of an unfavorable price movement. We can also place the exit at 0 above our entry price.
This will allow us to hold our position in the hope that profits will continue to grow. However, if we have 10,000 in current profits, I'm sure we don't want to lose 50% from it. Also, I don't think our stop out should still be just 500 above the entry price. For best results, our exit should be adjusted based on the current profit on the trade.
Many traders ask us about sustainability systems with multiple exit rulesI have to agree, however, with this general notion that systems with fewer rules are more stable. However, I must disagree with this general opinion. Consider the outputs in two very simple systems:
System A:
Uses a 1,500 MM stop out. (Limits losses to no more than 1,500)
When the profit is 5,000, stop out at the entry price plus 4,500.
System B:
Uses a 1,500 MM stop out. (Limits losses to no more than 1,500)
When the profit is 1,000, stop out at the entry price ("Break-Even Stop.")
When the profit is 2,000, stop out at the entry price plus 1,250
When the profit is 3,500, stop out at the entry price plus 2,500
When the profit is 5,000, stop out at the entry price plus 4,500
When the profit is more than 7,500, stop out at the previous day's low.
Some system traders may argue that because "System A" has fewer rules, it will perform better in the future. However, it seems to us that "System B" will perform better in the future, even though it has more rules. "System A" won't make any money if current profits never reach 5,000.
Only when the current profit exceeds 5,000 will there be stop output at the 4,500 level. "System A" is too limited, it only makes 4,500 profit or loses 1,500. You can see that "System B" is ready for a lot more options.
It is possible (though unlikely) that "System A" will show better test results on historical data. Nevertheless, we will trade with real money with "System B" with more confidence.
Simpler doesn't mean better when it comes to exit planning.