In Golden Rule 1, we discussed the importance of having a robust, quantified and clearly defined exit strategy for each and every trade or investment.

Irrespective of the style, strategy or timeframe, successful trading is very much about understanding and working with probabilities.  This has to be so in a world where there are no certainties, unless you are able to forecast the future.  In 30 years I have never found a single person ever who is able to forecast the future, so I am prepared to bet that you are in exactly the same position as me – having to work with a statistical advantage and allow probability to make profits for you over the long run.

Consequently our exit strategies must be designed within this same statistical framework and then there is one particular fact to accommodate – the bigger the profit you shoot for the less chance you have of achieving it.  This is why the best traders don’t play for home runs.  They treat trading as a business of slowly grinding out regular more modest profits.  “A day’s work for a day’s pay” is the mantra.  Notice how opposite this mentality is to that of a gambler who is constantly thinking that “the next one will be the big one”, only to be disappointed yet again.

With the chances of hitting big home runs being so low, most exit strategies should almost ignore that possibility.  But that does not mean that we won’t occasionally find we have caught a tiger by the tail.  So we also have to know how to adapt when luck, which is all it is, lends a helping hand.  Here is a great example of how we adapt our exits to handle a potential outlier event.

Sweet move in the sugar market

Let’s take a look at the sugar market – usually a pretty dull, boring market that for some reason flew into life this week handing us an unexpected gift.  On this chart I have marked up the last four days, Monday to Thursday.

Over the weekend our S-I-R swing trading system flashed up a buy signal in sugar.  So on Monday morning we dutifully bought some.  We got lucky on the entry buying fairly close to the low of the day.  As usual (Golden Rule 1) our exits were predetermined so exit orders were placed as soon as we were filled on the buy order.  Monday passed uneventfully for this trade, although I was pleased to see it close on the high of the day.  The best trades always work immediately and without giving you any grief so this was a good sign.

Tuesday arrived and blast off!  For some unknown reason (unknown to me at least) the whole world must have decided to buy sugar and we had this explosive move that you can see in this huge bar on the chart.  Our trades are exited in 3 equal parts and the first two exit orders were both filled during this big Tuesday rally.  Each exit has a specific purpose within our trading plan and a predetermined price.  Now here is the first trick – It is very unusual for two exits to be achieved the same day, so when this happens I know something unusual is going on.

Because two exits in a day is an outlier event, I switch tactic for the third and final exit.  As we potentially have the proverbial tiger by tail here I cancel that final exit order.  Instead we switch to using a trailing stop as there is now a very good chance that it will reward us disproportionately for holding on.

Here is the second trick – If the move is for real a huge range like we saw here on Tuesday will not be retraced into very far so the stop can be placed initially around the mid-point of the day’s range, i.e. around 16.50 here in Sugar.  This in itself will lock in a nice profit if triggered, so we will do OK even if Tuesday turns out just to be a one day wonder.  However the odds favour a much bigger move and as that move unfolds the stop can be progressively raised locking further profits in.

But when trailing a stop with the objective of catching an outlier event, remember to leave the market room to breathe, don’t trail the stop too tightly.  Here we saw nice follow through on Wednesday and Thursday, but the chances are that the market will pause and consolidate for a few days very soon.  If the stop is too tight we risk getting nicked out too soon.  So we will keep it well back for now, still being guaranteed a decent profit.  Once the market has consolidated and left behind a new swing low, then we will ratchet our stop up again and just see what unfolds from there.

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