Last Updated on June 15, 2021 by Oddmund Groette
Most traders spend almost all their efforts in finding the best entries. However, the exit is just as important as the entry. When to exit a trade can be of greater significance than when to enter!
In this article, we look at random entries and spend all our effort on making a better exit. By the end of this article, everyone will understand why entries are not as important as they think.
Does the entry matter at all?
Entry and exit are controversial topics among traders. Traders new to the market spend most of their looking for profitable setups but rarely spend much effort and time on the exits.
Most traders are always looking for better indicators and new trading tools so they can backtest more to find better entries. But mind you, the way you define entries has very little to do with your success or failure as a trader.
The truth is, entries can be done randomly and you still manage to make a profit. How is that possible?
It’s possible because the stock market is very mean-revertive.
This means, for example, that you can enter randomly, but exit on short-term strength.
We simulate random entries and defined exits
To make simulations we’ll make all entries in this article randomly. All entries are simply made by tossing a coin! Entry is at the close.
The test basket is 77 different ETFs, both equity and debt/interest rates, all listed on US stock exchanges.
The idea is to sell into strength. So the first exit is to simply sell on the first day after entry when the ETF closes above yesterday’s close. The exit is on the close. Here is the equity curve:
The portfolio holds a max of 10 positions at a time. If there are more trades generated, the program picks ETFs randomly. There is a high win ratio, but the winners are a lot smaller than the losers. Still, this simple strategy generates 6,2% in annual return since 2000. There are just 2 losing years. However, this is without commissions. We’re using entry on close and that means there should be no slippage unless our orders move the market.
What happens if we exit on the close which is higher than yesterday’s close plus yesterday’s 50 days ATR (average true range)? Here is the chart:
Annual return increases slightly to 7.4%.
In other words: with a completely random entry you manage a CAGR of 7.4%, which is not bad.