Chuck LeBeau’s Presentation

Traders Library Workshop Scottsdale, AZ

Major topics

Determining market directionStrategies for Up, Down and SidewaysPreparing the “setup”Entry triggersExit strategiesSimple advice on position sizingHow to monitor performance

Market Direction

Markets have three directions (not just two)Identifying sideways direction takes planning

Know your time frameDirection depends on your time frame

Select appropriate strategy for direction and time frame

Multiple strategies are required

Two Important Tools

Average True Range (ATR)

Average Directional Index (ADX)

These two tools will be used throughout this workshop and it is important that everyone have a thorough understanding of how they work and how we apply them.

RangeTrue Range

“True” range adjusts for gaps

Sketch - True range bars

Calculating the Average True Range (ATR)

The Average True Range is the largest of the following:

Today’s high minus today’s low.Today’s high minus yesterday’s close.Today’s low minus yesterday’s close.

Average True Range

Setting ATR periodsI usually use 20 bars as my default for ATR calculations but adjust to suit your purpose.Short time period ATRS (one to five bars) adjust very quickly to current volatility.Longer period ATRS (20 to 50 bars) adjust more slowly and are more reflective of typical or most common ATR.

Idea: Calculate two ATRS and use either largest or smallest ATR to suit your needs.

Applications of ATR

Determine direction using ATRExample: Compare current price vs. 10 days ago.

If current price is more than two ATRs above 10 days ago price then trend is UP.

If current price is more than two ATRs below 10 days ago price then trend is DOWN.

If current price is less than two ATRs in either direction over 10 days then trend is SIDEWAYS.

Note: Pick appropriate periods for your time frame.

Applications of ATRUse units of ATR for “Breakout” entry triggersExample: Buy if price moves 0.60 ATRs above the Open price. (Opening price breakout)Example: Buy if price moves 1.75 ATRs above previous Close. (Volatility breakout)Example: Buy if price moves 2.25 ATRs above current 20-day moving average. (Band breakout)Example: Buy if price moves 0.25 ATRs above highest high of last 20 days (Channel breakout)

Note: These numbers are just examples. Do your research to find best numbers for you.

Applications of ATR

Use units of ATR to set exit stops and profit targetsExample: Exit if price drops 2 ATRs below your entry.Example: Exit and take profits when open profit reaches 4 ATRS or more.

Note: We will be covering these and other uses of ATR in detail when we discuss Exits later today.

ATR Summary

Get to know and understand ATR and use it wherever possible.Because ATR automatically adjusts as volatility changes, its use in trading strategies makes the systems much more robust than using fixed dollar amounts or points.

Average Directional Index (ADX)

Whenever I look at a chart the first indicator I put up is the ADX.The ADX tells me what I need to know about the trend direction and the strength of the trends.The information I get from the ADX allows me to select the appropriate trading strategy for the current direction and trend strength.

Components of ADX

The ADX is made up of the Plus DI and the Minus DI

The Plus DI shows the amount of Positive (upward) directional movement.

The Minus DI shows the amount of negative (downward) directional movement

Plus DI

Minus DI

No DI

Plus and Minus DI measure Directional Movement

Market in balance ADX declines

Market out of balance ADX rises

Applying the ADX

The direction of the ADX is the key!A rising ADX tells us the trend is strengthening and we

should follow it.A falling ADX tells us the trend is weakening and we

can trade counter-trend.

Important: The absolute level of the ADX is not predictive. A low level indicates that the market was sideways. A high level indicates the market was trending.

ATR and ADX SetupsBefore selecting our trading strategy for a particular market we use ATR or ADX to tell us the direction and trend strength.

Examples of Trending strategies:Buy on breakouts (ADX, Channel breakouts)Buy on dips (Buy ATR or RSI dips)Buy continuation of trend (MACD)

Examples on non-trending strategies:RSI, Stochastics, Williams %R, Bands

Exit Strategies

Our exits (not our entries) determine the outcome of our tradesIf you are following a trend then good exits will cut losses and let profits run. If you are trading short-term you need to cut losses but you should exit on strength.Exits control risk and influence position size.

Four Exit Priorities

1. Set initial stop loss to protect capital.2. Add trailing stops to reduce risk.3. Protect open profits.4. Take profits efficiently.

It will usually require multiple exit strategies to accomplish all four of these tasks.

Three Important Exits

1. The Chandelier Exit

2. The Yo Yo Exit

3. The Modified Parabolic Exit

The Chandelier Exit

A stop is placed 3 (?) Average True Ranges from the highest high or highest close since entry of the trade.The stop moves upward as new highs are made.The length of the chain on the Chandelier will automatically adjust to changes in volatility.

Adjusting the Chandelier Exit

Start new trades with default exit of 3 ATRs from entry.As profits are accumulated, reduce the ATR units to lock in more profit.Example: when open profit reaches four ATRs, reduce Chandelier to two ATRs.Example: when open profit reaches six ATRs, reduce Chandelier to one ATR.

The Yo Yo Exit

The Yo Yo Exit is similar to the Chandelier Exit except the Yo Yo Exit hangs down from the most recent close.The Yo Yo Exit moves up and down every day with the closing prices. (Hence the name.)The Yo Yo must not be your only exit. Its purpose is very limited and it does not protect against big losses.The Yo Yo detects important “volatility reversals.

The Modified Parabolic Exit

This trailing stop moves closer and closer to recent price as new highs are made.

Other exits to considerTrailing channel exits at lowest low in X days.Moving average exits (Try 10 to 20 days in futures, 30 to 50 days in stocks)Entry signal in opposite directionTime Exit - Exit after N bars (Good for testing)Profit targets (Use ADX and ATR)High RSI - exit on strength - try 70 or 75

Basic Position SizingThe quantity you buy on a trade should be related to the risk. If risk is low, buy more. If risk is high, buy less.Once you know where your exit will be you will know your risk on any trade.Example: we have a $100,000 account and we want to limit each trade to only 2% risk (or $2,000). We want to buy XYZ stock at $25 per share and our stop loss exit will be at $23 so our risk is $2 per share. Our position size can be no more than 1,000 shares.

Monitoring Performance

You need to schedule reviews on a regular basis whether you are winning or losing.Don’t wait until you have losses to review what you are doing.Keep good records and review often.Look for trades that you should have made but didn’t.Keep a chart of the size of your winners. The first sign of trouble will be when winners get smaller.Don’t be afraid to make changes.

Key Points to RememberThree directions – Up, Down and SidewaysKnow and learn to love ATR and ADXUse entries based on direction and timeframeExits are criticalApply conservative money managementKeep records and perform periodic reviews

For more tips on trading please visit Chuck LeBeau’sWeb sites at TraderClub.com and SmartStops.net