Regina, SK Canada (PressExposure) February 28, 2012 -- Knowing when to leave a trade is just as important as knowing when to get in. Thinking about how much more money you can make after you have already seen profit makes it harder to be unemotional about leaving a deal.
Using emotions like fear and greed to drive a deal is problematic, which is why trading techniques can help you to make decisions more scientificallyTrailing Stop (Momentum-based)
The Trailing Stop is the starting technique when you are looking at when to leave a deal The main premise of this technique is to sell once a pre-determined point, normally just a small percentage below market value, is reached. The advantage of this stop-loss order is that when the sale happens, the dealer will know the minimum amount that they have made on the deal. The dealer's attitude to risk will determine exactly what level they set the stop-loss order at.
It's not easy to find the right point at which to set the stop at so that you can still make a good profit. This will be influenced more by emotion than calculation simply due to each persons level of caution when trading.
You might decide that you would like to monitor prices until they settle and then set your stop-loss order just below the consolidation level a little while after you have started the trade
In the case of over-valued stocks, a trader can be in the fortunate position of having set the stop to protect against losses meaning they can gain handsomely while the price remains inflated.
The Parabolic Stop and Reverse (SAR)
In contrast to the momentum-based method that may give continued gains, SAR will provide a more conservative approach. Operating better in a less volatile trading environment, this places stop-loss levels either side of the market and changes daily in line with the price.
A price chart will have this indicator drawn on it at levels that every so often cross the price in the event of a reverse or decrease in momentum of the stock.
The stop occurring at this crossover allows the opposing market to now offer a chance for gains.
Let's say that your security has sold so you no longer hold that position. You can now use a trailing stop to 'sell short' at the directly opposing position to the point that you had earlier 'stopped' at the reverse of the market. The parabolic tactic therefore gives the opportunity to gain from each aspect of the market taking advantage of the oscillating stock value.
But, it should be remembered that the stock's volatility will affect just how successful the SAR approach is. If the market isn't smooth enough, there is a danger that your stops are activated before you can make the gains you forecast, which could mean any you do make are outweighed by the costs of the transaction.
Secondly, if a stock lacks a meaningful trend then using SAR will mean that the stop point won't be achieved so you never secure your gains.
So, too choppy a market or too weak a trend and the SAR system will not be effective
But, if you can pick the right conditions at somewhere between a volatile market and one with weak trends, you might still be able to use SAR to get the right trailing stop point.
So, in conclusion....
Understanding the point at which you want to place your exit point will be driven by your attitude to risk as a trader.The more bullish may set their gain levels and potential loss limits by using the less specific method of determining trailing stops using an elementary criteria. On the other hand, the more cautious dealer might choose the SAR method to give both sides of the market to be used.
Either way, it is wise to remember that, if intending to use either of these methods, both are influenced by market environments.