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Working on Exit Skills
By Adam Grimes,
Author of The Art and Science of Technical Analysis: Market Structure, Price Action & Trading Strategies

One of the challenges developing traders face is learning to manage positions effectively. Think about it for a minute -- how many books do you know that show patterns and setups for trade entry? Now, how many do you know that focus on position management? We probably put too much emphasis on entry techniques, when much of our edge as traders comes from the decisions we make in managing positions.

I'm going to suggest an exercise that everyone can do to work on position management, but let me first share a few thoughts. Position management means several things: limiting the risk on your initial entry, taking partial profits (and losses, if you do that, though I present a very compelling case for not booking partial losses [edit: a type said "profits" in the first version of this blog entry] in my book, The Art & Science of Technical Analysis), looking for spots to add, and getting out entirely when the edge is gone out of the trade. Especially for newer traders, this is extremely difficult because of the emotional issues involved. One solution is to spend some time focusing only on the exits.

Many professional traders work in teams. In fact, when I was at the NYMEX, Mark Fisher went so far as to say that nearly every long-term successful trader he knew, on or off the floor, worked with a partner or a team. (Ari Kiev devotes quite a bit of space in Trading to Win to the importance of teamwork.) I worked closely with another trader for a few years, and we developed a technique that worked very well for us: whichever one of us generated the entry idea and got into the trade, the other one was responsible for getting out of it. Many times, a trader is very attached to an idea by the time we actually execute the trade because a lot of analysis and thought has already gone into it. You have visualized several scenarios and possible ways the trade might play out, and it is very easy to justify overstaying your welcome, or getting stubborn in a trade. If you are only responsible for the exit, you have no emotional attachment to the trade, and can see much more clearly. It's a lot easier to read the market and to make decisions.

Linda Raschke and Andrew Lo created a similar experience for a number of traders in Linda's chatroom in the early 2000′s. Several times during the trading day, Linda would call out a trade. If you were participating in this study, you were obligated to take the trade, but you could manage it however you saw fit. You could even get out immediately (usually for a tick or two loss), but you had to take the trade. Many traders participating in the study were surprised to find that they were remarkably profitable on the set of trades even though many of the entries were truly random. The message is simple -- exit techniques and position management skills have as much or more to do with profitability than entries.

So, how can you work on developing these skills? I would suggest something like this. Now, because you're dealing with psychological issues, papertrading is probably not very effective. I'd recommend doing this exercise with real money and actual positions. I'm going to make a separate set of suggestions for daytraders and intermediate term traders, but you can adapt the concept to your own situation.

This is a worthwhile exercise, and it might be a good idea to budget a certain amount of risk to it over a period of a few weeks to months. Remember, the whole point of this exercise is to remove any emotion associated with the entry or trade idea. How can you be attached to a trade you generated through a flip of a coin or a roll of a die? Exactly, you cannot, so now you can focus all of your attention on trade management and learning to respond to the message of the market as patterns unfold.

© 2012 Adam Grimes, author of The Art and Science of Technical Analysis: Market Structure, Price Action & Trading Strategies

Author Bio
Adam Grimes,
author of The Art and Science of Technical Analysis: Market Structure, Price Action & Trading Strategies, is the CIO of Waverly Advisors, an asset management and risk advisory firm headquartered in New York. He began his career as an independent trader focused on agricultural and currency futures, and moved on to manage a successful private investment partnership. Grimes's experience as a trader covers futures, equities, currencies, and derivatives, in time frames ranging from intraday to multi-month swings. Though he is primarily a discretionary swing trader, his methodology rests on a firm foundation of statistical and quantitative research. Grimes holds an MBA with an emphasis in finance and market microstructure, and has worked for a number of private investment firms, as well as having spent several years at the New York Mercantile Exchange.

For more information please visit http://adamhgrimes.com, Amazon.com, Wiley.com, and follow the author on Twitter