September 19

Peel Off Trading: What Is It, and How Do You Do It?

Last Updated on 19 September, 2022 by Samuelsson

(Peel Off Trading) Many traders focus on creating the best entry strategies and don’t give much thought to their exit methods. There are many ways to exit a trade, but one strategy used by most traders is the “peel off” method. You may be wondering what that means.

The “peel off” method (a term coined by Kevin Davey) refers to a way to exit a winning position whereby the trader exits a part of the position at a small profit (the “peel off”), and then allows the remaining part to run for as long as the trend lasts. For many traders, when the first part is exited, the stop loss for the second part is brought to a breakeven level.

We will discuss this under the following subheadings:

  • What is “peel off” trading?
  • How do you apply the method?
  • Is the “peel off” method more profitable than full exit?
  • Any analysis that supports the “peel off” method?

What is “peel off” trading?

The “peel off” method is a way to exit a winning position whereby the trader exits a part of the position at a small profit (the “peel off”) and then allows the remaining part to run for as long as the trend lasts. Meanwhile, the stop loss for the second part is brought to a breakeven level when the first part is exited.

While the term “peel off” was coined by Kevin Davey, a trader and an algo system developer, the method is as old as financial trading itself and has been used by many traders over the years.

The method is about exiting portions of the trading position at different levels, instead of exiting all the positions at one level. In its simplest form, the method goes like this: a trader with two contracts in open position exits the first for a small profit (the “peel off”) as the price moves in his favor and lets the second run, milking profits for as long as the trend runs while trailing the profits or at least keeping the stop loss at breakeven point.

It’s important to note that the “peel off” method is not a complete trading strategy in itself — it doesn’t in itself tell you when or how to enter a position — but rather, an exit strategy that allows you to earn as much as the market offers you while also reducing the risk of losing. In other words, unless a trading strategy is created around this method, it is nothing but a trade management approach aimed at reducing risks and still retaining the chance to profit as the market progresses in your favor. This is as opposed to exiting all positions at once.

How do you apply the method?

The “peel off” method can be used both in discretionary trading and algorithmic trading. In discretionary trading, the trader implements his strategy manually: he places the trades by himself and exits his position by himself. While exiting his position, he can choose to exit all at once or divide the position into two or more parts and exit one portion first and let the other portion run.

In algo trading, on the other hand, the trader only renders a computer algorithm, which monitors the markets, identifies qualifying trade setups, and places and manages the trades according to the written instructions. With algo trading, the “peel off” method can be implemented by writing a code for it as a trade management algorithm (different from the main trading algo) or as an overriding instruct for trade exits in a given strategy or a complete trading strategy is created around it and coded de novo.

Whichever is the case, there are different ways traders apply this strategy. Some simply use the half and half rule: exit the first half early and let the other half run. But some others use different combinations, such as 40%/60%: they exit 40% of their position early and let 60% run or the other way round. Some still use 30/70 or other combinations.

Is the “peel off” method more profitable than exiting all positions at once?

There is no direct answer to this as the profitability of any trading system does not depend on the trade management technique (which the “peel off” method is) alone. Profitability also depends on the trading strategy itself, so the strategy that is managed with the “peel off” technique can determine whether the technique performs better than exiting all positions at once.

That is, the “peel off” technique may be more profitable with one entry strategy than with another. For example, the technique may be more profitable when used on a strategy that is based on a trending market than when used on a strategy that is built for a range-bound market. To put it differently, you may find that it is better to use the “peel off” technique when trading a trending market than when trading a range-bound market.

Any analysis that supports the “peel off” method?

Kevin Davey tested the “peel off” technique with three unique strategies:

  1. An intraday 1-minute bar ES strategy that has no profit target, and a large stop loss
  2. A 30-minute bar Gold swing system, with both a profit target and a stop loss
  3. A 360-minute Japanese Yen swing system, with just a stop loss

He ran a baseline case where two contracts are traded in each trade and exited at once. He then ran the “peel off” case with two contracts entered in each trade but one contract is exited first at a profit of ProfSTS dollars while the other let to run.

The codes

He tested it on TradeStation, and here are the codes for the baseline case and the “peel off” case:

Baseline Code

Source: easylanguagemastery dot com

Peel Off Code

Source: easylanguagemastery dot com

Note that he defined ProfSTS as an input so he could optimize it to know when the “peel off” method is superior. He also made sure that each position opened with two contracts so he could compare the Return on Account for the two cases. Parameters used for the Return on Account include Net Profit and Maximum Drawdown, so both risk and reward are covered in one number.

The results

The overall walk-forward performance for each of the strategies was checked for the period from January 1, 2007, to January 1, 2015 (a period of 8 years). He used a 5-year in-sample data (from 1/1/2007 to 12/31/2011) to optimize the profit target exit level (input ProfSTS) and then validated on the out-of-sample data from 1/1/2012 to 1/1/2015 (3 years). As stated earlier, the optimization used the maximum Return on Account as its criteria.

Here are the results of the in-sample optimization for the 3 different strategies:

  1. With the intraday 1-minute bar ES strategy, the peel-off exit technique always produced results that were as good as, and sometimes better than, the baseline case of holding two contracts throughout the trade. The maximum Return on Account got to a profit target of $1,500, which meant that the Return on Account was more than double of the baseline case.
  2. Source: easylanguagemastery.com/
  3. With the 30-minute bar Gold swing system, the “peel off” exit method yielded results that were sometimes better and sometimes worse than the baseline result. Following the optimization, he used a profit target of $250, which gave nearly double the Return on Account when compared to the baseline.
  4. With the 360-minute Japanese Yen swing system, the “peel off” technique produced results that were always worse than the baseline case. The optimum profit level was at $3,250.

What do the results mean?

Having established the optimum profit target where the first portion of the position is to be “peeled off”, he ran the results on out-of-sample data from 2012-2015. He found that the results of the out-of-sample analysis were mixed: the ES strategy produced the same return as the baseline; the GC strategy performed better with the “peel off” exit method; and the JY strategy performed worse with the “peel off” exit technique. See the table below.

Source: easylanguagemastery.com/

As you can see, the analysis was inconclusive — on some occasions, the “peel off” technique performed better, and on some other occasions, it performed worse.

Key issues with the analysis

In the analysis, he simply implemented the “peel off” method as an exit strategy on already-existing trading strategies. Even though he could optimize the peel-off technique, the optimization was done independently of the underlying trading strategies. While this could give us an idea about the “peel off” method works in live trading, it is definitely not the best way to test its performance.

To accurately test the performance of the technique, the best thing would have been to include it as a part of a complete trading strategy at the beginning and then develop, test, and optimize the full trading strategy. This way, you have a complete trading system that you can determine its performance and tweak as necessary.

Nonetheless, we have seen that the “peel off” technique is a viable exit method to consider when developing our trading systems.


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