Entry AND Exit

[Tom Strickland <tstrickland@xxxxxxxxxxxxx>]

There have been a number of excellent comments lately about exit
strategies. It is often said that the exit strategy is more important than
the entry strategy. This isn't obvious, as it looks to me like they are of
equal importance. I'm not trying to split hairs, but rather trying to make
a point of unknown validity.

Here's the problem as I see it. When my system gives a buy signal, I enter
a buy stop at H + 2 ticks. If I'm successful and the price moves up, I'll
trail a sell stop below the current L, and when the system gives a sell
signal (assuming I haven't been stopped out previously) I enter a sell stop
at L - 2 ticks. Using the ATR (Average True Range) to represent the average
H-L range, the net profit from the trade is:

NetProfit = (maxH - ATR) -(minL + ATR) 

where:

NetProfit = net profit,
	maxH = the highest high while in the market,
	minL = the lowest low while in the market.

Thus,
	NetProfit = maxH - minL -2*ATR.
	


Thus, the net profit is two times the ATR less than the gross profit using
these types of entries and exits. That is, buying at the top of the range
and selling at the bottom costs about 2*ATR. 

As an example, consider the Dec Chicago Wheat contract. It has been in a
downtrend since March and has dropped from ~$3.70/bu to ~$2.60/bu for a
gross profit of ~$1.10/bu. However, there were three significant minor
corrections during this period and these caused exit signals in my system.
Thus I am trading the intermediate down trends and their individual gross
profits range from 20¢ to 40¢. Furthermore, the ATR for wheat is about 6¢
so for a 20¢ gross, the net gain is only 8¢, or 40% of maximum. For a 30¢
gross the net is 18¢ or 60%, and a 40¢ trade yields a net of 28¢ or 70%.

Now suppose that the system is profitable for 50% of the trades and that
the loss on the losing trades is one ATR. The overall system profit per
trade then becomes:

	SysProfit = 0.5*NetProfit -0.5*ATR, or
		  = 0.5*(maxH - minL) -1.5*ATR,

	where SysProfit = the system profit per trade.

If the gross profit for profitable trades (maxH - minL) is 20¢, SysProfit
is only 1¢. It is 6¢ for a 30¢ gross, and 11¢ for a 40¢ gross. However, if
I had traded only the major trend and neglected the corrections, the gross
would have been $1.10 and the SysProfit would have been 46¢.

What this says to me is that it is very tough to make money trading moves
of 20-30¢ using the entry and exit schemes that buy on the high side of the
range and sell on the low side. If this correct, there are two
possibilities that come to mind: 1) go for the larger moves, or 2) find
some entry/exit techniques that buy below the top of the range and sell
above the bottom. 

Sorry this took so long. What do you think? Please let me know if I have
made any errors either in the math or in the logic. 

Anyway, this is what worries me about trading systems at this time.

Tom Strickland