Here at QiT we use an algorithm to identify stock picks, which forces us to make decisions about our trades before we put them on. This is something all traders should do yet few accomplish. When I started QiT, and before I started down the Yellow Brick Road that got me to where QiT is today, I was truly amazed at how many decisions had to be made before I was able to dissect a very simple trade.
Let’s take, for example, a simple moving average crossover type of trade. Here is a short list of decisions you have to make before you even consider entering a trade:
- What timeframe are you using? Daily? Weekly? Minute? Hourly?
- Which Market are you going to use? All of them? US Only?
- Which subset of #2 are you going to trade? Large Cap? Small Cap? ETFs?
- Which moving average type are you going to use? Simple? Weighted? Exponential?
- Which averages are you going to use? Of course, #1 has to be answered before you can answer this one.
- How are you going to enter a position? Market? Limit?
- What criteria will you use to exit a position?
- How are you going to exit a position? Market? Limit?
- Will you use a Stop Loss or a Dynamic Stop?
These are some of the decisions you have to a make if you’re trading your own simple trading system and you don’t want to back test it. If you want to back test it, there is a whole host of questions that need to be answered well before you get to anything that resembles trading. But that is not what this article is about so I won’t digress there.
I am going to start as if we’ve made quite a few of these decisions already so I can highlight how QiT enters and exits a position.
The entry is quite simple, we use a limit order. The thinking behind this is, if we identify a good candidate to trade, let’s make it a great entry and let the market come to us. It’s simple, its elegant and it works.
The exit is altogether different in that we have to give some of the control of the trade back to Mr. Market. I don’t like it, and I’m sure you don’t either, but that’s just the way it is. With an entry, if we get filled great, but if we don’t that’s OK as well. When exiting a position, we don’t have the luxury of, “its Ok if we don’t get filled,” we have to get out. Now we have to think about how to do that as elegantly as possible.
One way to exit is with a Market AT Open and get out first thing tomorrow. But another way is to exit with a Limit Order. Fortunately with algorithms we can test both ways and is why you’ll see both types of exits in the QiT portfolios.
Exiting with a Market at Open is easy enough because you just place an exit at Market for the next morning. However, exiting with a limit order is a little more involved and before you jump into that boat, you have to explore all the possibilities:
- What limit price do you use?
- What happens if the market opens below your limit price and never reaches it all day? How do you get out?
This is an excellent example of why working with an algorithm is superior to trading your own system that resides in your head. You are forced to make these decisions before you ever put on a trade – or change your trading system.
Here is how we exit a position with a limit order:
- Place a limit order to exit tomorrow X% below the close of today. (We will do optimizations on this percentage to ensure we use the best one).
- Place an MOC order to exit the position if the limit does not execute.
- Both 1 and 2 need to be tied together with a One Cancels All (OCA) order. Some brokers call this a One Cancels Other, or One Cancels Another but you get the point. I’m sure it’s obvious as to why these two orders need to be tied together. If the limit order executes intra-day, you don’t want to Sell at the Close, so the MOC order has to go away when the limit fills.
I know this sounds complicated (it’s really not) but what it does is add more reality to your trading. It’s a lot easier to just exit at market the next morning but by just adding one more order – the OCO/MOC order – you are taking more control of your trading and that is always a good thing.