Unwinding
Unwinding is the process of closing an open position, including the intermediary goals of capital protection, cost protection, risk protection, earnings protection and profit taking.
There are multiple unwinding strategies that are separate from the research strategies (although some may intentionally fit together). The strategies share common order types, including the Initial Stop, Cost Stop, Risk Stop, Pure Profit Stop, Closing Stop, and Time Stop.
The Initial Stop serves the goal of capital protection. The stop is placed at the time of order entry and is never pulled or moved away from the price, although it is reduced or cancelled when other stop loss orders are placed.
The Cost Stop serves the goal of cost protection, including the commissions for the opening order, the Cost Stop execution, and at least one additional execution (more if multiple unwinding steps are expected). The Cost Stop is expressed as a price for a certain number of shares, e.g. $20.05 for 100 shares or $20.10 for 50 shares.
Example: Trade fee is $10, Position Size is 100, and Fill Price is $20. In this case the Cost Stop needs to cover $30. Therefore the Cost Stop for 30 shares is $21. The Cost Stop for 60 shares is $20.50.
The Risk Stop serves the goal of risk protection. Risk Stop calculations are directly proportional to the Target Risk Amount, or R. Risk Stops are expressed as a price for a certain number of shares.
Example: Purchase Price (and Fill Price) $10, Initial Stop $9.50, Position Size 100 shares. The Target Risk Amount (and Actual Risk Amount) is $50, or 1R. The 1R Risk Stop for 100 shares is $10.50. The 2R Risk Stop for 100 shares is $11. The 1R Risk Stop for 50 shares is also $11.
Risk Stops are generally incremented along with the price, and may be implemented as a trailing stop or set of trailing stops. The idea is to first eliminate risk and then to lock in small profits. Note that by âeliminate riskâ we are only referring to executions of Stop Loss orders â this provides no protections against gapping. Risk Stops may include commissions and predictable (average) slippage as applicable.
A Pure Profit Stop serves the goal of earnings protection. The intention is to close a portion of a position and in doing so recover the original cost of the entire position (Position Price) including all commissions. The fewer shares sold, the better, as the remaining position will earn all profits.
A Pure Profit Stop may often be executed as a Market or Limit order, particularly near the market close. The risk of gapping down and losing a guaranteed profit can be avoided by executing a Pure Profit Stop, as the gap risk is then only applied to the profit (not the entire position).
It is especially desirable to take profits when other market opportunities are available â that is, when other orders are not being executed due to a lack of Cash Available. A Pure Profit Stop frees capital for other trades while allowing the existing trade to earn further profits.
The Closing Stop serves the goal of profit taking, and is the final sell order for a position. Since Initial, Cost, and Risk stops often close a position, the main time a specific Closing Stop is required is after a Pure Profit Stop. The Closing Stop may be implemented as a trailing stop. Note that according to the trading rules the Closing Stop should never be adjusted away from the price.
A Time Stop is a conceptual order used to control existing stop loss orders. Using a Time Stop in a strategy allows positions to be closed without hitting the stop loss order(s), for example if there are only slight gains or losses. A Time Stop can ratchet existing stop loss orders or cause the execution of a Limit or Market order. Time Stops are flexible and very much strategy specific.
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I will post a Learning Example showing how all these stops may be applied to a trade.
Comments are welcome.
Thanks,
Chabah
