When & How to take profits.
How to scale out of your winning trades in swing trading.
Mastering entry techniques and following a stop loss plan is one part of trading, and serves you well by exposing yourself to the upside while limiting losses. The other part of trading, which is taking profits, is what makes you money.
It’s an emotional challenge dealing with profits. You are thinking about exiting too soon, leaving too much on the table, or giving back the profits if the stock turns.
In that light, this article helps clarify some basics of how you can scale out of winning trades and make the most of your winners to keep your account equity trending up.
It is what I do and allows me to forge a stable equity curve.
(August 2022)
Know your math
Swing traders should know how much, on average, they lose on losing trades and how often they lose. The residual in the latter is the proportion of time they win.
My long term numbers look like this:
Once you have these numbers you can go on to calculate how much you need to win on an average to achieve the desired return after a set number of trades.
For example, in the table below, you can see how the returns change as your win rate and the Gain/Loss Ratio change. If you lose half the time on an average with a 5% stop loss and win 2x that average loss in your winning trade, you end up making 37% returns after 50 trades (not adjusted for trading costs). If your average return is 3x, you end up with a much higher 86%.
Knowing this math can help you determine how should you manage your winning trades so that you don’t end up taking profits too soon and also not hang on too late on to your winning trades.
Know how your winners move.
Each swing trader will have winners that will move varying amounts once they are in the money. Accordingly, the average loss will also wary.
For example, if you trade small-cap stocks, your winners will move much quicker than when you trade large-cap stocks. The stop losses in small caps could also be wider due to their natural higher volatility.
For each trader, some winning trades are blockbusters, some break even or turn a small profit and a vast majority are average winners. The key is to hold all these trades for the optimum time to realize their potential.
For now, you just need some data on how much each of your winning trades move. This data will come handy in the next step.
Protect your average and breakeven
The next step in scaling out of your winning trades is to exit a decent portion (or all) of your trade as the price hits your target average gain level OR you predefined exit criteria.
For example, if scaling out is your preference and you risked 5% on a trade, and your average target gain rate is 2x your risk, you can exit half of your position at 10% gain and move your stop on the rest of the position to breakeven. You can ride the balance of the position for a bigger gain with other profit-taking mechanisms.
Ride the balance for maximum profit potential
One of the mechanisms to ride profits can be to keep exiting the rest of the position in parts as the return hits higher multiples of risk. For example, you can exit the next half at 4x gain, the next 6x gain, and so on.
The other mechanism can be to take the help of indicators like moving averages or MACD to exit the entire balance position (my preference). You can wait to exit when the price closes below a short-term moving average like 10-day or 21-day or wait for the signal line to cross below the MACD line to exit.
When you use indicators, you will take the maximum benefit of the momentum with an objective exit plan.
How all of this would add up
Here is an example of what your average return would look like with varying proportions of trades delivering different returns based on your exit plan.
In the table above, we have assumed that we exit 36% or 9 of our 25 winning positions at 6% profit by exiting half at the targeted 12% return and the rest at break-even. We exit the next 32% or 8 of our positions at the targeted 12% return. We exit the other 16% or 4 positions at 18% profit and the balance positions at 24% and 30% profits equally.
With this, the average winner now comes to 13.2% and if our average loss is 5%, we get a win/loss ratio of 2.64, which can deliver decent returns if you are right half of the time and are able to compound regularly.
I use weekly charts and average losses circa. 7% and average wins circa. 26%. It can be done, you just need a strategy and immense discipline.
Taking profits can also be a binary decision and you can keep exiting all your positions the moment it hits your targeted return. For example, you can keep exiting positions once they hit 2x or 3x your risk. That works well for a lot of traders. However, it entails trading more actively and you would not be riding big winners. If you have a system that throws a lot of opportunities to trade, that could be a better approach for you.
Personally, I prefer to ride the winners with full position size, and exit positions with full position size. I find this gets the best risk reward outcome and is achieved more passively.
Conclusion
As we saw in the above example, there can be numerous permutations and combinations to deal with profitable trades. The key point here is to follow a plan when it comes to taking profits. Your plan could incorporate protecting your breakeven, maintaining your average win return, and riding the profits to maximize your return on winning trades.
As you practice more, this part will come naturally to you and will be entrenched in your trading system, freeing you of the anxiety from winning trades and the continual decision making requirements. Make sure it is predefined whichever route you take.
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