Tuesday, June 29, 2010

Risk Rockets and the Strategic Exit

I received a thoughtful question regarding my exit strategy on the SPY risk rocket introduced in Fire Up the Boosters. Those familiar with the original post will recall we entered this bullish play to exploit the breakout over $111 in the SPY. The initial target was $113.50 or one ATR above the entry price. The trade turned out to be a heart-breaker as the SPY made a healthy attempt at following through to the upside but fell just shy of the target when it topped out at $113.20.

After coming within a hairs breadth of capturing the profit, and seeing last Monday's gap get sold into with a vengeance, I opted to bail when the SPY returned to its breakout point of $111. It obviously would have been nice had I adjusted right on the open on Monday when the SPY was close to my target, but hey, hindsight's 20-20 (click chart to enlarge).

[Source: MachTrader]

While I had a chance to bail close to my break-even point in this scenario, what might traders do if the stock moves adversely from the get-go on this type of play? My typical default exit plan for virtually any and all directional bullish plays is to bail once I've been proven wrong. When trading based off of a price pattern, such as a breakout, being proven wrong usually occurs when the pattern fails. I usually draw a line in the sand under some type of support level and declare myself wrong if that level gets taken out.

As they say, there's nothing wrong with being wrong... there is something wrong with staying wrong.

I suppose trader's could hedge the risk rocket by selling in-the-money calls when the underlying moves south. Though in my experience most trader's are better off just exiting since hedging opens up a whole new can of worms.

For related posts, readers can check out:
Evolution of a Bullish Risk Rocket
Adjustment Thinking and the Salvation Syndrome

1 comment:

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