Popular Exit Strategies The Good, the Bad, and the Ugly

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1 Popular Exit Strategies The Good, the Bad, and the Ugly A webcast presentation for the Market Technicians Association Presented by Chuck LeBeau Director of Analytics

2 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

3 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

4 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?

6 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!!

9 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?

12 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?

15 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

18 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 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!

21 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!

22 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.

23 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.

24 Range True Range True range adjusts for gaps

25 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.

26 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.

27 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.

28 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.

29 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.

30 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 overbought/over-sold oscillators would also work. (Stochastics, William s Percent R, various bands, etc.) We will also be discussing the use of targeted exits.

32 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).

34 Thanks for attending For additional education and many informative articles be sure to visit and You are welcome to contact me at if you have any questions about this presentation. (I will be happy to send you a copy of these slides via .) Good luck and good trading!

Exit Strategies for Stocks and Futures

Exit Strategies for Stocks and Futures Presented by Charles LeBeau E-mail clebeau2@cox.net or visit the LeBeau web site at www.traderclub.com Disclaimer Each speaker at the TradeStationWorld Conference