Trade Management - Learn to Grab the Cash and Dash

Traders know that identifying a stock market top is virtually impossible -- barring from hindsight.
Countless money managers advocate adding to positions that are showing a profit. In contrast, I believe in 'Grab the Cash and Dash'. This short article will show you how to capture your profits even if the Wall Street moves in your direction and then stubbornly retraces and takes away some or all of your profits.
I trade with a market timer that follows the S&P 500. The SPX is an ETF (Exchange Traded Fund) that represents the S&P 500. Consider the chart of the SPX. The market is in a downtrend. The timer indicates a bearish signal on November 11th 2008.

At the bottom of the chart, there is a yellow histogram that indicates the percentage points gained as the trade progresses. It shows the percentage gains of the SPX during a timer signal; the white horizontal lines are at the 5%, 10% and 15% gain levels.

Gains of 5% have been routine over the years; 10% gains occur less frequently and are often accompanied with a pull-back; gains of 15% are rare and usually transient. This money management system takes advantage of the stock price excursions.

The Strategy Defined
This "How to take the money and run" strategy is simple.
a) When the SPX price has moved 5%, sell 25% of your shares.
b) When the SPX price has gained 10%, sell 50% your residual shares.
c) When the SPX price has moved 15%, sell 50% your remaining shares.

"How to take the money and run" utilizing Ultra and Contra ETFs
SSO and SDS are Ultra (2X Leveraged) ETFs that are frequently traded to represent the S&P 500. Both the SSO and SDS are liquid; i.e. they have very high daily volume, and the difference between their bid and ask prices is within a few pennies. The benefit to the trader is that he can enter and close trades for very small slippage costs.

The SSO ETF is traded during rising markets; SDS, a Contra (inverse) fund, is traded during falling markets. SSO and SDS gain approximately twice S&P 500's gain. For example, if the S&P 500 rises 5%, then SSO moves up 10%. If the S&P 500 moves down 5%, then SDS moves UP 10% - yes, up, because it is an inverse fund. By exploiting these two ETFs, we can capture profits when the market rises or falls; even in your IRA account.

Now that we have a means to capture profits in a rising or falling market, let's look at the effect that applying the "How to take the money and run" money management strategy does to our profits in a market that retraces. This money management plan not only captures profits as they are produced, but, at the same time, it reduces your funds at risk.

Instead of adding to the trade, increasing risk, we take money away from the trade. This compensates for the increasing risk of a pullback as the market rises. The strategy works best in volatile markets such as those we have been experiencing since the fall of 2007.

An Example
As an illustration we are going to use the trades represented in the red rectangle in the lower left of the chart. The yellow histogram at the bottom of the chart shows that the market had gains over 15% during this trade. Because SPX's price was falling, we traded SDS to take advantage of the bear market. (SDS rises as the market falls because it is an inverse ETF, remember.)

Table A


Gains without money management
To illustrate the calculations in the table An above, we are going to buy 1,600 shares of SDS FOR $94.31 on 11/11/2008. This is an investment of $150,896. If we hold SDS until 11/25/2008 and do not employ any money management strategy, we will experience a small loss of $288.

Gains employing money management
Watch the effect on ETF profits when using this money management strategy.

1. On 11/12/2008 the SPX has risen over 5%. Therefore, we will sell 400 [25%] of the shares of SDS at 104.94 for a gain of $4,252.00; we still have 1,200 shares of SDS.
2. On 11/19/2008 the SPX has gained over 10%. We want to capture more of the move, so we will sell 600 [50%] of the shares at 112.94 for a gain of $11,178.00; we still have 600 shares.
3. On 11/20/2008 the SPX has gained over 15%. We will sell 300 [50%] of the shares at 127.97 for a gain of $10,098.00; we still have 300 shares.
4. On 11/25/2008 we sell to close the remaining 300 shares. We sell 300 at 94.13 for a $54 loss.

Summing up the gains in steps 1, 2, 3, and 4 above, the profits come to $25,474.00 instead of a loss of $288. This represents a gain of 16.88%. This gain was made possible by selling shares at prescribed levels to take advantage of the price moves.

It is vital for investors to take profits when they present themselves. The concept of adding to a trade as the trade progresses adds appreciable risk. Moreover, in these volatile markets, it is important to have a money management strategy that reduces risk rather than increasing risk.

My web site, SPXTimer.com is dedicated to assisting investors improve their investment performance using the SPXTimer combined with sound money management. We aim to achieve exceptional gains while keeping safety primary.
Many of our strategies have been developed principally for IRAs. These strategies show you how to safely profit in both bull and bear markets. Our market timer is unique because it includes market sentiment when calculating the market direction.