Profit Taking Strategy

J

JT47319

When you decide to cash in, what is your method and why? The two most common I've seen is either the half and half where you lock in your profit once you reach your price target and let the rest ride. Or the all or nothing method, selling at the near top (or what you think is the near top).

I typically go with the latter method, but just today I was reminded why this could go against me. I was riding KLAC from its lows and sold at the morning rally when it started showing weakness. Of course, it was just a ploy to shake out the weak hands and off it went. I hit myself on the head for being faked out. Luckily, I was able to jump in on a pullback and ride the rest way up. Again, I did the all or nothing method.

I know Pristine and others suggest the 1/2 method, but the trading books I've read by Dr. Alexander Elder suggest that this method is not the most optimal. As I am still quite new to trading, I'd like everyone's philosophy on this.
 
I just read Van Tharps book " Trade your way to financial Freedom". It forced to reevaluate my profit taking strategy.

Here was the money management method I was using.
example: assume a risk of .15 and a profit objective of .30 for stock xyz. sell 1/3 of my position as soon as .10 was gained and sell the additional 2/3 at .30. My logic was that usually a stock would go a little in my favor before stopping me out for a loss. However, when I crunched the numbers ( assuming a 50% win rate), It would be necessary for 5 out of every 6 losses to make .10 on the 1/3 position. And if you have a system where the win rate is more than 50 % percent , then the ratio of partial losses/losses has do be even greater.

crunch the numbers with different win rates and reward/risk ratios and see what you come up with for different profit taking strategies.

I am going to do some more research, but I am leaning towards an all or nothing approach.

this is a very good topic and doesn't seem to get the attention it deserves.

Good Luck
 
Rereading through the Pristine book, I think the reason for the half-and-half method is that it gives you a psychological edge. I don't know if the numbers add up, but I suppose that's a valid excuse.

In retrospect, my first play would have made me feel better had I done that. I would have caught that "high" and then rode "higher." But on fewer shares, I don't know if I would have added to my position like I actually later did today. And my second play, I would have sold at what turned out to be the real high and not the decline that I actually sold into (I hard lesson I learned: sell when you can, Not when you have to).

Doing the math, if I had sold half at what I thought was the first high and half at either what I sold at EOD or even at the final, final high (where I was desperately wanting to sell at, gosh darn it), I wouldn't have made as much money as I ended up actually getting by the all-or-nothing method.
 
There is no simple answer and depends entirely on your system.

Specifically, how reliably will you get an initial move off your method before a retrace .. and how likely it will be to reach it's price target.

But, assuming you have a good entry and exit point method.. all in and all out will be among the best performing bottom line.
 
I tried to backtest this several years ago on the S&P futures and found that the best results with my entry came with an all or nothing approach. I think that conclusion would apply even more forcefully today if you are trading globex, because it is so easy to get in and out.

It is tempting to take quick profits on a portion but you are violating one of the cardinal rules of trading: let your profits run and cut your losses quickly. In other words, you will take stop outs with the full position but take profits on only a partial position.

I can see why a position trader, particularly one carrying large positions, would want to scale in and out, but I am talking about daytrading. Personally I don't like having to manage partial positions during the day either.
 
Quote from AAAintheBeltway:

I tried to backtest this several years ago on the S&P futures and found that the best results with my entry came with an all or nothing approach.
More...

I am now backtesting and papertrading some mechanical ES system that confirms what you say.
 
I prefer to offset half of my position at the objective and the other half with a trailing stop. Sometimes the market gives more than you expect on the latter half of the position, and sometimes you give up some profits on the second half. Let those winners ride!
:)
 
I attached an excel spread sheet to illustrate different profit taking methods. Each section contains 3 examples:

1. all or nothing

2. Taking partial profits at point that is equal to risk. (ie.. risk 1.5, take partial profit at 1.5) where only 1 out of 5 trades is an outright loser with no profit taken.

3. Taking partial profits at point that is equal to risk. (ie.. risk 1.5, take partial profit at 1.5) where 3 out of 3 trades is an outright loser with no profit taken.

there are examples that show liquidating 1/3 and 1/2 of position for profit at point that is equal to risk.

The examples are based on ES with each point equal to $50. Some of the examples involve fractional position sizes ( though this wouldn't happen in the real world, it gets the point across).

Notice that as percent win and reward/risk increase, the case for taking partial profits diminishes.
 

Attachments

A profit taking strategy should, I believe, attempt to let a winner play itself out. Or simply, you want to let that winner run for as much as you can.

So, firstly, you need to be willing to give back a good deal of open profits to do that. I'm not a fan of "profit targets", in the sense that, "if it gets to X, that's it, I'm taking my profit". But I do have targets in that, "until it gets to point X, I'm willing to take my entire loss, after it gets to point X, I'll let it retrace 60% before exiting, if it reaches point Y, I'll let it retrace 40% from there, once at point Z, I'll only stomach a 25% retrace". Those aren't my actual numbers, because they vary on the specific trades, but that is the way I take profits.

That means that you're always leaving some profit on the table. I know a lot of people are very uncomfortable with doing that. But, it's the only way I know of being able to let your winners run.

However, I'll also exit early if I see something in the market that I don't like. That's more a case where experience comes into play. And, if you find letting profits retrace too gut wrenching, it is not hard to find "something in the market" that you don't like, so you can take your precious profits. However, if you're willing to be mature about it, reading the market for a sign to get out early can be quite useful.
An example would be this morning's brokers, which shot right out of the gate, while the general market was being dragged down by the nasdaq. After the first sign of the move faltering, just past 10, I decided to book the profits. (Whereas had the nasdaq traded roughly evenly with the spoos, I would've definitely sat through the retracement.)

EDIT.
Oh, and I also always take profits with my full position. I sometimes also scale into a trade after it has started to move my way, and have a separate stop for the scaled in position. As you might imagine, this does lead to some whipsawing, but I very much prefer to have my largest position on when a trade is going my way.
It works if you can stomach it, but I'll admit this isn't for everyone.

 
I scale out of profits for many reasons. The most important being that its psychologically pleasing to ring the cash register every so often. Also it smooths out my daily acount value.

This leads into another discussion of.. whats better having a high win % with small gains.. or low win % with huge gains.... They are both profitable.. but it all comes down to psychology.

To answer your question.. you can backtest profit taking strategy any way you like.. and they will always give different results for different setups. Sometimes they will favor all or nothing and sometimes favor scalling out... But it all comes down to psychology.. What you feel more comfortable doing. In reality there is no better way to take profits ( assuming you try to let them run as much as possible)... but make sure you pick one method and be consistent with it to the end.



--MIKE
 
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