AW10 says Focus on the EXITS... so also says VAN K. THARP in his book SUPER TRADER : Copy pasting the relevant portion :
Exits Are the Key to Making Money
As I mentioned earlier, I decided to prove to myself that one
can make money with random entry. When you employ random
entry, you are giving up any advantage that your particular
setup and entry edge have. The only way you can make money
is to catch a strong trend occasionally, make sure your losses
are not too big, and practice proper position sizing.
How can your exits help you catch a strong trend? In a
random entry system, when you exit, youll enter back into a
trade again and lose another $100 in slippage and commissions.
Thus, you want your initial exit to be large enough to make sure
that you dont exit very often. At the same time, you dont want
to enter into a trend in the wrong direction, which would cause
you to pile up huge losses. Thus, to make the random entry
system work, I needed an initial stop that was big enough to
keep me in the market while it was just making random noise
movements or moving sideways. I chose to exit at three times
the 20-day volatility or average true range.
I like to keep things simple, and so I made the abort exit
and the profit-taking exit very similar. I trailed three times
the 20-day average true range from the closing price. Thus,
if the price moved in my favor, so did the trailing stop, and
if the volatility shrank, the stop also would move in my favor.
The stop was moved only in my favor, never against me.
As a result of this exit, I was able to stay in sideways markets
a long time and not get stopped out. If I entered against a trend,
I was stopped out quickly and hoped the random entry would
reenter in the direction of the trend. Also, if I was lucky enough to
enter in the direction of the trend, my stop kept me in the trend
for a long time. It was that easy. With that simple exit, the random
entry system was able to follow the golden rule of trading (cutting
losses short and letting profits run) and thus make money overall.
The first kind of exit you need to know about is the abort
exit. This is the exit that defines your initial risk, or what Ive
been calling 1R.
In reality, there are two kinds of initial exits: tight ones
(1R is small) and wide ones (1R is big). Each has some
distinct advantages. The wide exit keeps you in a trade for
a long time and gives it a chance to start working for you.
Thus, if you like to be right, you have more of a chance with a
wide exit. Examples of this include the three times volatility
exit mentioned above for the random entry system and a 25%
retracement exit, which works fairly well for stocks. If you
want to buy and hold stocks as long as you can, simply use a
25% trailing stop as an exit, adjusting it up whenever the stock
makes a new high.
The other type of initial exit is the narrow exit, which
defines 1R as a very small amount. If you want to be right, you
dont want this sort of exit because youll be stopped out a
lot. However, if you want large R-multiple gains, youll find
some advantage to tight initial exits.
Lets look at an example. Suppose you buy a $50 stock
when it breaks out from a consolidation with power. If you put
your stop below the consolidation, say, at $45, youll probably
be right a lot. However, if the stock goes up $10 in price, you
will have made only twice your risk, or 2R.
Suppose you put your stop in at $49, a dollar away. If the
move has power behind it, the stock should keep moving and
you wont be stopped out. Furthermore, if the stock goes up
$10, youve now made a 10R profit, or 10 times your initial risk.
In fact, you could be stopped out three times in a row, getting
three 1R losses, and then make your 10R profit. You are right
only 25% of the time, but your total profit is 7R.
At this point you might be thinking, Yes, you make 7R, but
you started out with a very small risk. Thats where position
sizing comes into play. What would happen if you risked 1% of
your account on every trade? If you are up 7R, youll be up
about 7%, no matter how big or small R is for one unit.
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