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underlying reasons for making the trade. It also requires that you consistently use your perception and behave free of disempowering beliefs or vices. Only then will you be able to improve your methodology. |
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The challenge to exit strategies is that you are exiting a trade that has in the past demonstrated a strong continuity of thought about where it is heading. In every case the market will not climb to the sun or sink to the center of the earth without signs of hesitation. Every time the market expresses itself, there will be resistance by the opposing force, either immediately or eventually. If you devise a strategy that exits at the first sign of resistance, you might be getting out of your trades prematurely. Yet if you wait for a lot of resistance, you are probably leaving a lot of money on the table. In fact, your trailing stop could be just slightly lower than your exit price, if you wait for a lot of resistance. |
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Money management is covered in depth in the next chapter. However, your exit strategy and your stop strategies must mutually reinforce each other. You want to capture as much profit as possible while simultaneously reducing your exposure to loss. |
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The dilemma is that if we make our exit strategy too sensitive, we open ourselves to exiting a long-term trend prematurely. We may then be forced to reenter, adversely affecting our total profits. However, if we exit only when the trend clearly has changed, we will leave a lot of money on the table. Should the perceived trend we entered on turn out to be not that long and/or fail to move up or down significantly, we could exit the trade at a loss. The other challenge with waiting for the trend to change is that we have to allow the market so much room to retrace part of its move that our protective stop will remain at a price that, if hit, would result in a loss or a significant reduction of profits. So what is a trader supposed to do? |
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The answer that I have found is best demonstrated by example. Let us assume that I have a very simple methodology, based on weekly data, that uses the RSI and defines a bull trend as whenever a bearish divergence occurs, and a bear trend as whenever a bullish divergence occurs. I will go short on Monday's open, only after a bearish candlestick appears in the ensuing bear rally; when a bullish divergence is present, I will go long by reversing those rules. My exit strategy is to remain short until there is a bearish divergence, at which point I exit on the open on Monday of the following week. My stop loss is determined by finding the range of the week that made the bearish candlestick and dividing the range by 2. This value is then added to the open of Monday (where I got short); this then is my stop loss price. |
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Let's take an example that occurred a few years back and bring it into the present. Looking at a weekly yen chart, I see that on 2/9/96 there was a |
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