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Popular Exit StrategiesThe Good, the Bad, and the Ugly
A webcast presentation for the
Market Technicians Association
Presented by Chuck LeBeauDirector of Analytics
www.SmartStops.net
What we intend to cover
Problems with most trailing exits
The good, the bad, and the ugly
Proposed solutions
Chandelier exits
Modified Parabolic
Targeted exits for short-term traders
Other methods to exit on strength
Challenges of using trailing stops
1. Always know when to sell
2. Limit risk & maximize profits
3. Avoid “whipsaws”
4. Have a reentry
5. Ease of use
Most popular methods of
setting trailing stops are
seriously flawed
We will now look at some
common methods of setting
stops and discuss their
strengths and weaknesses
Percentage trailing stops
The Good:
Ease of calculations
Objective (no chart analysis)
The Bad:
Stops get closer or farther away based on price levels
No adjustment for trend strength or direction
No research on what percentages work best (8%, 10%, 25% or
some other percentage ???)
The Ugly:
Subtract percentage from where? From entry? From recent high?
After price breaks by selected percentage – where is next stop?
Moving Average trailing stops
The Good:
Ease of calculations
Objective (no chart analysis)
The Bad:
Which moving average should you use?
No adjustments for direction of trends
No adjustment for changes in volatility
The Ugly:
Too slow- rapidly rising prices quickly get too far away from MA
After MA is broken – where is next stop?
They will drive you crazy in sideways markets!!
Exit at “Support levels”
The Good:No calculations
The Bad:Highly subjective – expert chart analysis required
Support levels do not move up as prices accelerate
No adjustment for changes in direction or volatility
The Ugly:
Too slow- Rapidly rising prices quickly get too far away
Not suited to downtrends – where is next stop?
Exit at Trend Lines
The Good:No calculations
The Bad:Highly subjective – expert chart analysis required
No adjustment for changes in direction or volatility
Frequent whipsaws in sideways market
The Ugly:
Too slow- Rapidly rising prices quickly get too far away
Not suited to downtrends – where is next stop?
Exit at Parabolic SAR
The Good:Accelerate very quickly to keep pace with rising prices
The Bad:Complicated calculations requiring computer and software
No adjustment for changes in direction or volatility
Frequent “whipsaws” in sideways markets
The Ugly:Not suited to downtrends – where is next exit?
Does not let profits run for big gains
Exits at SmartStops.net
The Good:Cuts losses short while letting profits run
Automatically adjusts to trend direction
Automatically adjusts to changes in volatility
Completely objective – no charts to read
Provides exit prices in advance of use
Choice of short-term and long-term time frames
Timely email notification when exit prices are hit
When necessary, exits move farther away to avoid whipsaws
The Bad:Service is only free for 14 days on a trial basis
The Ugly:There is no ugly – SmartStops are beautiful!
Quick comparison
to “buy and hold”
From the beginning of 1998 thru July 2009, a buy and hold
approach using 1,000 shares of the SPY (ETF for the S&P 500)
would have lost $6,940.
If SmartStops exits were combined with a simple reentry at 20 day
highs, over the same period the result would have been a profit of
$52,970.
The SmartStops exits improved results over this ten-year period by
a total of $59,910!
How the SS strategies work
1. The exits are adjusted according to trend direction:
In an uptrend the exits trail at a distance in order to let
profits run.
In a downtrend the exits are moved closer to protect more
capital.
In sideways markets the exits trail just outside the range of
random price swings to avoid “whipsaws”.
How the SS strategies work
2. The exits are accurately adjusted to changes in
volatility as measured by Average True Range:
The “normal” price ranges are mathematically defined in
units of ATR.
To avoid “whipsaws” the exits are placed outside the
normal price swings.
Only an “abnormal” period of weakness will trigger an exit
signal.
Range
True Range
“True” range adjusts for gaps
How the SS strategies work
3. In upward trending markets the “Chandelier Exit”
allows the exits to keep up with price acceleration:
A stop is placed (3?) Average True Ranges from the highest high since
entry of the trade or the highest high over some defined period of time.
Because the stop is attached to the high point it moves up at the same
rate that the high moves.
The length of the chain on the Chandelier is measured in units of ATR
and will automatically adjust to changes in volatility.
Adjusting the chain on the Chandelier Exit keeps the stops from getting
too close or too far away.
How the SS strategies work
4. A highly modified Parabolic indicator allows the
stops to gradually accelerate without getting too
close:
The Parabolic is modified to make it a long-only indicator and it never
reverses.
The acceleration of the Parabolic is slowed so it does not accelerate too
fast.
The Parabolic is modified so that it is not allowed to move inside the
range of normal price activity.
How the SS strategies work
5. Combine the exit signals with a foolproof and
intelligent method of reentering trades after an exit:
Try to find indicators such as MACD and ADX that can signal when
strength has returned to a position you may have previously sold.
Our research has shown that following a reentry methodology as
simple as the “Donchian 4-week breakout” or the “Turtles 20-day
breakout” would prevent missing any major opportunities.
SmartStops uses two proprietary reentry methods. When the trend is
down the reentries are slow to trigger. When the trend is up the
reentries will trigger quickly.
Advice: Overcome “Whipsaw” Paranoia
The only way to completely avoid whipsaws is to not use protective
stops. Unfortunately that drastic solution would expose investors to
unacceptable levels of risk.
In order to mitigate the consequences of a premature exit signal a plan
of reentering needs to be in place.
Our studies clearly show that over the long run the benefits of using
protective trailing stops will far exceed the expense or lost opportunity
costs of an occasional whipsaw.
Learn to accept the occasional whipsaw as simply a cost of doing
business and make sure that you are always prepared to renter if a
strong upward trend is resumed.
Advice: Learn “Position Sizing”
Use your protective stops to determine your correct “position size”. Here
are the simple steps:
1. Select a percentage level of risk relative to the size of your portfolio.
Example – a portfolio of $100,000 might select a risk level of 1.5% so
risk should be limited to $1500 on each trade.
2. Pick a stock and find your precise worst-case exit based on your exit
strategies. Example – buying a $25 stock and the exit stop is at $22.
Risk is $3 per share so correct position size is 500 shares. ($1500 risk
limit divided by $3 risk to your exit point)
Remember, controlling risk is a two step process: use protective
exits and then make sure you control your initial position size.
Advice: for Short-term traders
Most of the exits discussed in this presentation work best for long-term
trend followers who are able to hold positions until weakness is detected.
Short-term traders may use trailing stops for protection but should plan to
exit on strength in order to maximize short-term profits.
Here is one of my favorite exit-on-strength techniques. It is extremely
simple and uses Welles Wilder’s RSI indicator. However other over-
bought/over-sold oscillators would also work. (Stochastics, William’s
Percent R, various bands, etc.)
We will also be discussing the use of targeted exits.
Use ATR to set profit targets
Units of ATR are perfect for setting profit targets because they contract
and expand as volatility changes.
In volatile markets ATR profit targets will be bigger. In quiet markets
ATR targets will be smaller.
Short-term traders might expect maximum profits to be about 2 ATRs
using a 3-period ATR calculation.
Although it is more difficult and less accurate, targets can also be used
by longer-term traders using a longer ATR (20 periods) and a larger
ATR multiple (4 or higher).
Thanks for attending
For additional education and many informative
articles be sure to visit www.SmartStops.net and
www.TraderClub.com.
You are welcome to contact me at
[email protected] if you have any questions
about this presentation.
(I will be happy to send you a copy of these slides via
email.)
Good luck and good trading!
