Entry and Exit Strategies
The exact method you decide to use will relate to how you determine what the operating mode of the market is, how you define risk, your beliefs, and your money management rules. There are many different entry techniques you could use, and they all relate to your risk tolerance.
Suppose a trader has come to the conclusion that the market is, or is about to, demonstrate a strong continuity of bullish thought. Here is a partial list of strategies the trader could use to get long:
1. Waiting for a retracement in price:
A. To a bullish trend line.
B. To a certain percentage of the previous move.
C. To retest a previous resistance area.
D. To retest a previous support area.
E. For a certain price or mathematical formula behavior to occur, signifying an end to that retracement.
2. Waiting for the price to continue up and:
A. To go through a price that has been mathematically calculated.
B. To go up (break through) through a previous price that previously acted as support or resistance in a declining market.
3. Waiting for a mathematically derived study to do something.
4. Getting long as soon as the continuity of bearish thought has been broken.
5. Getting long as soon as the realization that the technicals and the fundamentals are in alignment—that is, they both have a continuity of bullish thought.
The critical fact is that you must come up with a set of rules that you trust to get you into a bull move every single time.
By having exact rules on what made you enter the trade, you will be able over time to reexamine the underlying logic of these rules and determine if the methodology is profitable. Note that we do not care if our reasons are logical (although that would be nice), only that they are quantifiable and repeatable, can be consistently applied, and are profitable.
What do you believe is more important: your entry price or exit price? Most experienced traders will put more emphasis into developing rules to exit a trade. This is because when you are flat, and only looking at a market, your rational mind is not being unduly influenced by your emotional mind. When a soldier is in the heat of battle, his life will often depend on the cold, detached, unemotional abilities of his general. Your exit rules will be a major defense against your emotional feelings and ego.
Here are a few beliefs traders might have on why they want to buy at a price higher than it currently is:
1. By continuing higher, the market has demonstrated that it is willing to go higher.
2. By waiting till a higher price has been accomplished, the market is indicating that it will probably continue higher.
3. By waiting for the bulls to rally prices above a price level that the bears should have defended, the market is indicating that the bulls are in firm command.
Now here are a few beliefs traders might have on why they would rather wait for a retracement in price or in a mathematical formula:
1. By waiting for a retest of a valid trend line, the trader could use a small stop. The trend line has already demonstrated its power to rally prices in the past.
2. By waiting for a percentage retracement, the trader is acknowledging that some market moves will retrace 33, 50, or 66 percent, and by waiting the trader will be going long at a much better price that may allow for a tighter stop.
3. By waiting for a retest of a previous resistance or support price level, the trader is acknowledging the significance of how what was resistance for the bulls should now be support, or previous bullish support should remain support, provided that the continuity of thought is still up. Here too, tighter stops may be used.
4. By waiting for the retracement, and then for the price or a mathematical formula to behave in a certain manner, the trader can look for a particular pattern that in the past has represented the resumption of the bull move. The stop order can then be placed closer to the entry price.
The reason that traders wait for their mathematically based study or program to do something before they enter is that they have been able to identify a pattern through their math or program, allowing them to enter into a trade with the best probability that the trade is going to work.
Getting long as soon as the continuity of bearish thought has been broken allows the trader to get into a bull move before the rest of the traders have realized the continuity of thought has been broken. Getting long when the realization that the technical and the fundamentals are in alignment allows the trader to be fairly certain that the bull market will continue. It means that the trader will not be chopped to death—that is, both the technical and fundamental traders share the belief that the bulls are or will be the dominant force.
Here are some metaphors from various traders to describe the markets:
"The markets are like two armies in a never-ending series of battles.
My job is to hitch a ride on the food truck of the stronger force."
"Trading is the ability to figure out what all the other traders are reading into the future."
"Every time I enter the market I feel like I just jumped into shark-infested waters, and I am their lunch. For me to make money, all my indicators have to be perfectly aligned."
"Trading is like a game of 'hide and seek' that children play. I wait quietly and patiently for the market to present a profitable opportunity to come and play!"
Your exit strategy is critical to your financial survival. Your exit strategy will invariably be related to your entry strategy and your risk tolerance.
An effective exit strategy requires active monitoring, and more work than it took to enter. In most cases a stop placement strategy is fairly automated. The reason the exit strategy takes more work is that when you are in a trade your disempowering beliefs are attempting to create emotions that distort your ability to perceive the market. It takes a conscious effort to overcome this.
Effective exit strategies incorporate valid reentry strategies.
Depending upon your trading methodology, you may want to exit the trade whenever the continuity of thought has been broken or has weakened.
The biggest hindrance to investing the time needed to devise an exit strategy is your ego.
The important thing is to use a quantifiable methodology to determine if the market is weakening. You have to be able to identify exactly what caused you to think that the market was weakening.
The market will always tell you when your methodology needs to be refined—by the red ink that you see. This demands that you use pinpoint precision in determining the 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.
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.
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?
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.
What I have found in order for my exit strategy to keep more profits is that I need to go to a shorter time period. The next shorter time frame from weekly is daily (the common belief). I will continue to wait for the continuity of thought to change on a daily basis from bearish to bullish. Consequently I have to change my exit strategy to exit when there is a bearish divergence, on a daily chart. When it does change, I will now exit the short yen trade the next day.
A lot of professional traders do not base their trading decisions on anything but one time frame; however, some use multiple time frames.
Interestingly, if the shorter time frame (in this example, daily) continues to exhibit a continuity of thought indicative of a bull market, then I will be ready to go long when the time frame I was using (weekly) generates a buy signal according to my methodology.
I should stress an important point about using multiple time frames. There are advantages and disadvantages to all time frames. Monthly and weekly charts are common among large institutional traders, since this is one of the ways they can move thousands of contracts without adversely affecting their profitability. Weekly charts tend to exhibit much less volatility, and the continuity of thought tends to last longer. Traders incorporating monthly and weekly data use much larger stops than a similar methodology using a shorter time frame. Daily charts are where the bulk of the traders live and die. The level of volatility is naturally higher, and the stops are smaller, in daily charts. Traders using charts constructed from hourly, n minute, and tick charts have the tightest, smallest stops and also experience the most volatility.
For more Information
* The Stock Investor, IPO and Equity Offerings, Fixed-Income Securities, Derivatives, Bonds, Futures and Options, Investment Decisions and Risk Management,*
The exact method you decide to use will relate to how you determine what the operating mode of the market is, how you define risk, your beliefs, and your money management rules. There are many different entry techniques you could use, and they all relate to your risk tolerance.
Suppose a trader has come to the conclusion that the market is, or is about to, demonstrate a strong continuity of bullish thought. Here is a partial list of strategies the trader could use to get long:
1. Waiting for a retracement in price:
A. To a bullish trend line.
B. To a certain percentage of the previous move.
C. To retest a previous resistance area.
D. To retest a previous support area.
E. For a certain price or mathematical formula behavior to occur, signifying an end to that retracement.
2. Waiting for the price to continue up and:
A. To go through a price that has been mathematically calculated.
B. To go up (break through) through a previous price that previously acted as support or resistance in a declining market.
3. Waiting for a mathematically derived study to do something.
4. Getting long as soon as the continuity of bearish thought has been broken.
5. Getting long as soon as the realization that the technicals and the fundamentals are in alignment—that is, they both have a continuity of bullish thought.
The critical fact is that you must come up with a set of rules that you trust to get you into a bull move every single time.
By having exact rules on what made you enter the trade, you will be able over time to reexamine the underlying logic of these rules and determine if the methodology is profitable. Note that we do not care if our reasons are logical (although that would be nice), only that they are quantifiable and repeatable, can be consistently applied, and are profitable.
What do you believe is more important: your entry price or exit price? Most experienced traders will put more emphasis into developing rules to exit a trade. This is because when you are flat, and only looking at a market, your rational mind is not being unduly influenced by your emotional mind. When a soldier is in the heat of battle, his life will often depend on the cold, detached, unemotional abilities of his general. Your exit rules will be a major defense against your emotional feelings and ego.
Here are a few beliefs traders might have on why they want to buy at a price higher than it currently is:
1. By continuing higher, the market has demonstrated that it is willing to go higher.
2. By waiting till a higher price has been accomplished, the market is indicating that it will probably continue higher.
3. By waiting for the bulls to rally prices above a price level that the bears should have defended, the market is indicating that the bulls are in firm command.
Now here are a few beliefs traders might have on why they would rather wait for a retracement in price or in a mathematical formula:
1. By waiting for a retest of a valid trend line, the trader could use a small stop. The trend line has already demonstrated its power to rally prices in the past.
2. By waiting for a percentage retracement, the trader is acknowledging that some market moves will retrace 33, 50, or 66 percent, and by waiting the trader will be going long at a much better price that may allow for a tighter stop.
3. By waiting for a retest of a previous resistance or support price level, the trader is acknowledging the significance of how what was resistance for the bulls should now be support, or previous bullish support should remain support, provided that the continuity of thought is still up. Here too, tighter stops may be used.
4. By waiting for the retracement, and then for the price or a mathematical formula to behave in a certain manner, the trader can look for a particular pattern that in the past has represented the resumption of the bull move. The stop order can then be placed closer to the entry price.
The reason that traders wait for their mathematically based study or program to do something before they enter is that they have been able to identify a pattern through their math or program, allowing them to enter into a trade with the best probability that the trade is going to work.
Getting long as soon as the continuity of bearish thought has been broken allows the trader to get into a bull move before the rest of the traders have realized the continuity of thought has been broken. Getting long when the realization that the technical and the fundamentals are in alignment allows the trader to be fairly certain that the bull market will continue. It means that the trader will not be chopped to death—that is, both the technical and fundamental traders share the belief that the bulls are or will be the dominant force.
Here are some metaphors from various traders to describe the markets:
"The markets are like two armies in a never-ending series of battles.
My job is to hitch a ride on the food truck of the stronger force."
"Trading is the ability to figure out what all the other traders are reading into the future."
"Every time I enter the market I feel like I just jumped into shark-infested waters, and I am their lunch. For me to make money, all my indicators have to be perfectly aligned."
"Trading is like a game of 'hide and seek' that children play. I wait quietly and patiently for the market to present a profitable opportunity to come and play!"
Your exit strategy is critical to your financial survival. Your exit strategy will invariably be related to your entry strategy and your risk tolerance.
An effective exit strategy requires active monitoring, and more work than it took to enter. In most cases a stop placement strategy is fairly automated. The reason the exit strategy takes more work is that when you are in a trade your disempowering beliefs are attempting to create emotions that distort your ability to perceive the market. It takes a conscious effort to overcome this.
Effective exit strategies incorporate valid reentry strategies.
Depending upon your trading methodology, you may want to exit the trade whenever the continuity of thought has been broken or has weakened.
The biggest hindrance to investing the time needed to devise an exit strategy is your ego.
The important thing is to use a quantifiable methodology to determine if the market is weakening. You have to be able to identify exactly what caused you to think that the market was weakening.
The market will always tell you when your methodology needs to be refined—by the red ink that you see. This demands that you use pinpoint precision in determining the 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.
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.
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?
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.
What I have found in order for my exit strategy to keep more profits is that I need to go to a shorter time period. The next shorter time frame from weekly is daily (the common belief). I will continue to wait for the continuity of thought to change on a daily basis from bearish to bullish. Consequently I have to change my exit strategy to exit when there is a bearish divergence, on a daily chart. When it does change, I will now exit the short yen trade the next day.
A lot of professional traders do not base their trading decisions on anything but one time frame; however, some use multiple time frames.
Interestingly, if the shorter time frame (in this example, daily) continues to exhibit a continuity of thought indicative of a bull market, then I will be ready to go long when the time frame I was using (weekly) generates a buy signal according to my methodology.
I should stress an important point about using multiple time frames. There are advantages and disadvantages to all time frames. Monthly and weekly charts are common among large institutional traders, since this is one of the ways they can move thousands of contracts without adversely affecting their profitability. Weekly charts tend to exhibit much less volatility, and the continuity of thought tends to last longer. Traders incorporating monthly and weekly data use much larger stops than a similar methodology using a shorter time frame. Daily charts are where the bulk of the traders live and die. The level of volatility is naturally higher, and the stops are smaller, in daily charts. Traders using charts constructed from hourly, n minute, and tick charts have the tightest, smallest stops and also experience the most volatility.
For more Information
* The Stock Investor, IPO and Equity Offerings, Fixed-Income Securities, Derivatives, Bonds, Futures and Options, Investment Decisions and Risk Management,*
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