This happens to be one of many posts on the topic, but one of the most important topics we tackle as traders. Maybe I might say something different this time that lights a fire? Or perhaps I might even talk myself out of my own preferences. I counted 22 e-mails or comments within the last couple weeks that requested a post on this subject. Since I solicit requests...I will fulfill them... even if there are plenty of archived articles that have covered most of this.

Let me start by saying that if there were some secret ingredient as to when to exit a trade, would trading be a challenge? There are so many different methods and theories as to how to work this magic, not to mention all the technical indicators that offer help. I will try to comment on several of them, but make sure you know up front that I am not going to tell you how or when to exit your trades. This is why trading is an art and not a science. There is no right or wrong way or even a "best way" to do this. I will write on a few "OptionAddict Approved" methods and hopefully this will provide some pointers.

Exit strategy is mostly dependent on the style of trader. Short term traders will have different objectives that the intermediate or long term trader. Option traders will have different methods than the stock trader. Mechanical traders will have a different approach than discretionary traders. So on and so forth. As I write this I will try to mix and match methods with trading style....and by the way, I will focus on exits where you are taking profits, not losses (taking losses is easy!). This material will be a close duplication of my last Master Talk presentation.

Signs of Weakness- This is such a subjective terminology. What is considered weak? Price moving against you? Small daily price range? Indecision? Using this as an exit will be a totally discretionary observance on your part. What I normally recommend is using candle patterns. Remember my post a few weeks ago titled "What is Weakness?" Click Here if you need a refresher. The idea was to give some insight to a few candlestick patterns (which are towards the bottom of my importance checklist) and used these confirmed patterns as signals of weakness in the short term trade. These will be slightly ahead of the oscillators in the "speed" department.

Support & Resistance- A very simple minded methodology. Use this in the same manner that we discussed Apple yesterday. When entering trades on a trending stock, get in as close to the floor/ceiling (depending on your trade) and use this trend line to dictate when the stock has ceased to trend and when exit your trade. This is one of the very best methods for your intermediate term trader and a very definitive method.

Using the Oscillators- Another way to take confirmed exits is through a direction change on your oscillating indicator (MACD, Stochastic, RSI, CCI, etc). For example, you take a bullish trade when the indicator turns up and you exit the trade when it turns back down. The biggest problem I have with this is that the default indicator is usually lagging price by quite a bit. I would recommend shortening the time frames used to calculate this indicator (Disclaimer: shortening the time frame will make it move faster, which might result in more whipsawed trades). An example would be taking the stochastic which is calculated using a 14-5 time period, and changing it to a 7-3 making twice as sensitive.

Using Specific Exit Indicators- The other night I discussed two technical indicators I have used in the past to exit trades. They are...

ATR- (Average True Range)
This is a stocks daily volatility indicator. In fact I have a post that covered this in my archives somewhere. Anyhow, it will give you an average daily range. For example if your stock has a tendency to fluctuate (up or down) an average of a dollar, you would arrive at an ATR of 1. Since some stocks will fluctuate enough to stop you out intraday use this indicator to see how wild the stock may be, and set your stop outside this value. Another example... if my stock has an ATR of 2 perhaps I set my stop to trail the stock at a $2.50 value?

Parabolic SAR (Stop and Reverse)
This indicator is calculated similar to bollinger bands and is based on the individual stocks deviations. If you add this to your interactive chart, there are lines drawn on the chart that will somewhat represent support and resistance lines. Once these are penetrated, this is when you close the trade and reverse it (Ex. Sell your calls, buy puts).

Using Daily Price Movements- An easy way to use daily price bars as a sign of weakness is to see a closing price below the prior days close.Or perhaps a close below the prior days open. Personally I would prefer candle patterns but I know others who use methods like this and swear by it.

Posted by Option Addict on 12/15/2006 at 10:42 AM | Permalink