Profit Taking Strategies

Managing a trade after the entry is probably the most difficult part of trading to master. The entry, initial stop, and profit target are all decided before the trade is made. Once a trade starts moving in your favor, it becomes an emotional struggle if you don't have a trailing stop strategy to protect your profits. There are several trailing stop methods and ultimately it is of utmost importance that the trail stop meshes with the profit target strategy.

A trader needs to decide on what philosophy they will adhere to for taking profits. Some traders such as Trader-X have a specific target for each trade and use the trailing stop to protect themselves in case of a reversal. Other traders such as Trader Mike prefer not to set a target and ride a trade as long as possible. The trailing stop is used to capture as much profit as possible while not letting too much get away if it reverses.

An important point to understand is that one method exits into strength, and the other exits on weakness. The trailing stop has different functions for each, but ultimately, it is there to protect profits.

Another aspect that is often overlooked, is that the trailing stop needs to match the expected duration of the trade. It doesn't make sense to target a 2-6 month trade and follow it with a trailing stop that would force you to exit prematurely.

A reader named Muaad asked about different trailing stop strategies, so I am highlighting a few methods below.

I am using PHLY to illustrate some strategies. It has a nice trend that allows several different strategies to be compared. I traded this stock recently, so the trailing stop strategy I used will be illustrated as well.

Here is a basic chart showing the trend and the recent base. The stock recently cleared this base and may be poised to move higher. However, it is short term overbought and has some divergences on RSI and MACD.


The first stop method is a tight stop I like to use for most of my swing trades. Since I am typically looking to capture only a few day move and sell into strength, I employ a very tight trailing stop that serves to protect the trade from a reversal. The basic strategy is to raise the stop to just under a strong candle that closes over the high of the previous candle. I will also raise it if I see a reversal pattern forming. I highlighted where I moved my stops on this specific trade on the chart below. As always you can click on the image to zoom in.



A second method that some traders use is to sell on a break of a rising trendline. This is certainly a viable method for certain stocks, but you need a valid trendline and the stop should be based on a close below the trendline. I use this method mostly on intraday charts. An important point to add is that usually it is best to wait for the candle to close because support areas should be thought of as zones and not specific areas. A trendline is a place where you would expect support, but price may dip below and slingshot back.


Another method for trailing stops is under a recent pivot low. The same works in reverse for shorting. Basically, a trader would keep the initial stop in place until a stock forms a higher pivot low and then confirms it by moving back higher. The trader then moves the stop under this new low, and waits for the stock to work its way higher. Keep repeating until stopped out. I normally don't use this method as it is geared towards longer term trades. While it has weaknesses, if you catch the beginning stages of a large move, then this method can capture a large part of it.


The last method I will highlight is the Chandelier exit. This is a great strategy for intermediate term trades and is flexible enough to be geared towards different types of traders. The basic premise is that a trader trails a stop based on the stocks volatility. This specific method trails a stop under the recent highest high by a multiple of the ATR (average true range). A typical value is three times the ATR. I've seen several traders such as Alexander Elder, Thomas Bulkowski and Dr. Van Tharp employ similar volatility stops.


There are several other methods such as moving average crossover, straight percentage stop, indicator based stops, etc., but I will reiterate that the most important thing is to ensure that the trailing stop strategy fit with the overall profit taking strategy. I will also vary the trailing stop method depending on overall market conditions. If the markets are overbought on intermediate and long term time frames, then I will be even more aggressive in my stops. If they are just coming off a bottom, then I may keep them a bit looser then normal.

As I mentioned before, this is one of the most difficult strategies for a trader to master. Dr. Brett Steenbarger recently posted on some of the psychology behind this subject and how he dealt with it in his own trading. I struggled with this area myself, and I ended up with a compromise that eases my emotional struggle with profit taking and allows my trade to continues moving in my favor.

When I enter a trade, I typically have a target in mind. As the stock moves in my favor, I will scale out in even portions (usually thirds or quarters) into resistance such as a previous pivot high or a moving average. This satisfies my urge to take profits, while allowing me to stay in the trade. I will trail my stop, usually with my custom trailing stop. When I am down to 1/3 to 1/4 of my original shares, I will either try to be aggressive in exiting into strength, or I will move over to a chandelier stop and let the rest ride. A lot depends on the stock and the market environment.

If you look back to the PHLY trade above, you will notice that I exited entirely. This is because I wasn't sold on this particular stock due to the divergences, and because if it pulled back, I assumed I could get another entry on it. As it stands, the stock is still below my exit, and looks like it may drift back to the 20sma. If it prints a nice pattern there, then I may re-enter.

I know I only briefly touched on these strategies, so if anyone has specific questions or comments, feel free to post them in the comments section. I would love to hear from some other traders on how they handle this topic as well.

Hope this helped some of you,



DT