Decision: When to Exit

Elaborating on an older question:

Mark,

For me, the difficult decision is when to close a trade.

I'm trying to find a specific algorithm, for when
to do this. I'm leaning towards a "point of maximum acceptable loss".
As yet I have not come up with a method to determine what the "point of
maximum acceptable loss" would be. Perhaps some factor multiplied by
the maximum credit or ?? Any ideas regarding this?

Thanks.
All the best,

JB

***

Hello JB,

There are reasons for exiting any trade.  Perhaps:

You changed your mind and no longer have confidence that your trade premise will come true

If you trade without a premise, then it's appropriate to exit when:

Remaining profit potential is small and not worth the risk

The probability of earning money is low

A possible large loss is imminent; prudence says: exit

You lost the most you are willing to lose for this trade


The exit decision is based on the current position and the risk of loss vs. potential gain.  You may want to consider the probability of earning cash going forward, but how can the cash collected when you initiated the trade have any possible relevance?  The past is history.  

I've said this repeatedly, but it seems to me that it's often necessary:  You own this position right now at its current price.  Do you believe that this is a good position to hold?  That should be all that matters.  If it's a position that you honestly (with no emotions getting involved in the decision) believe is worthwhile to own and that it still fits within your comfort zone, then hold (with or without an adjustment).

If you cannot make such decisions without emotions, then be certain you have a trade plan for each trade, with pre-determined exit points.  Stick to the non-emotional plan until such time as you are able to trade efficiently under stressful conditions.  The plan is far more likely to have a good solution to the problem than you – trading under duress.

I'm in agreement that establishing a maximum loss for each trade is a sensible thing to do.  Thus, the one exception to my rule above is to exit when that maximum loss is reached.  Obviously this assumes that your rules for establishing such a maximum are reasonable, but for this discussion, let's assume they are.

When trading a 10-point iron condor, if you collect a $0.25 credit (this is a horrible trade for many reasons), are you going to exit as soon as the trade reaches $0.50?  Is that $0.50 bid or offer?  If it's the bid, you will not be able to pay that price to exit.  If it's the offer, you may be exiting very early.  The point is, how are you going to determine that when loss equals your original credit (or any multiple thereof)?  Please don't use this idea.

I suggest trading by the evaluating what you own.  Do you want to own all, or any part of the position(s)?  If 'yes continue to hold.  If 'no,' exit. Th only condition is to make rational and non-emotional decisions.

754

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2 Responses to Decision: When to Exit

  1. Tom 08/02/2010 at 3:16 PM #

    You mentioned that collecting a 0.25 credit is a horrible trade for many reasons. I have been following various options trading services, and there are 2 that I have come across that actually use this exact strategy (Wicked Profits and Cyclespreads); they recommend very small credit spreads on indexes that are far out of the money. It seems they have been pretty successful using this strategy but they also have certain months where they don’t issue a trade recommendation because of excessive volatility.
    Is the reason that you don’t like collecting low credits for far out of the money spreads because of the bad risk:reward ratio? It would seem that with this strategy, there can be 10, 20, or 30 months in a row where the spreads never come under pressure. The key is to have a risk management plan so you know what to do when the market eventually does make one of these sigma 3+ events. Obviously you also couldn’t close the spreads early when you are bringing in such a low initial credit. You would generally have to let them expire worthless to gain the full credit. During options expiration week, you can usually close out spreads that are far out of the money for .05 to .10, however this still will take a fairly large bite out of the very meager credit that you initially took in (closing for .10 is 33% of the initial 0.30 credit). Are there other negatives that I’m missing?

  2. Mark Wolfinger 08/02/2010 at 4:17 PM #

    Tom,
    I think you have it right.
    Full post on this topic tomorrow 8//3/2010
    Regards