When Should You Take Profits?

Reader Steve is still unclear about an important part of Trend Tracking, namely when to take profits. He writes as follows:

Thanks again for your great blog and newsletter.

You have really helped me improve my trading (and the way I look at markets). I have appreciated you reviewing your entry and exit strategies. I do have one question. When do you take profits?

I have had a few ETFs go quite a bit higher, then fall back to trigger my stop over the course of a couple of weeks. Looking back, I could see they were quite extended above their short term moving averages. When a fund rockets off, should I take some profits along the way? Or should I wait until it falls in momentum or triggers my stop? Any wisdom you can provide would be much appreciated.

Again, thanks for you generosity in sharing your experience.

The general idea is let your trailing stop loss be your guide when to get out, either to limit losses or to lock in profits. Here is how I have described it in more detail in my Investment Policy Statement under the “Risk” section:

With Trend Tracking, we set up a clearly defined risk limit. Upon executing the purchase of an investment, we immediately establish a trailing sell stop point of 7%. In other words, as prices rise, the stop loss point rises as well. This essentially fulfills 2 functions:

1. It limits our losses in case the trade goes against us, and

2. It locks in our profits if prices continue to rise until the trend ends

As you can see, Trend Tracking, along with the disciplined use of trailing sell stops, greatly reduces the risk.

For example, if we allocate 10% of portfolio value to a certain ETF, and prices decline right away and trigger our sell stop, our risk is to lose about 7% of the 10% investment. That means the effect on the total portfolio is about -0.7%. (Be aware, however, that the final price maybe slightly better or worse than the 7% loss objective due to market conditions.)

This sensible approach allows us to keep these losses small; they are not only part of investing but necessary in order for us to be prepared and ready to participate in the next major up trend whenever it presents itself.

Sometimes it may take several buys and sells, also called whip-saw signals, before the major trend establishes itself. Investor patience is a requirement!

In other words, if the trend continues your way to the upside, you trail your sell stops along with the rising prices until the trend eventually reverses and triggers your exit points. Using this method, you eliminate any emotional decision making and let the market tell you when it’s time to get out.

About Ulli Niemann

Ulli Niemann is the publisher of "The ETF Bully" and is a Registered Investment Advisor. Learn more
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