Exit Strategies for Traders

The Good, the Bad, and the Ugly

A presentation by
Chuck LeBeau
Director of Analytics,
y , www.SmartStops.net
p

Legends of Trading Forum

Chicago 2010
 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 Most popular methods of
setting trailing stops are
2
2. Li i risk
Limit i k & maximize
i i profits
fi seriously flawed
3. Avoid “whipsaws” We will now look at some
4. Have a reentry common methods of setting
stops and discuss their
5. Ease of use strengths and weaknesses
 Percentage trailing stops
The Good:
Ease of calculations
Objective
j (no
( chart analysis)
y )
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
j (no
( chart analysis)
y )
The Bad:
Which moving average should you use?
No adjustments for direction of trends
No adjustment for changes in volatility
The Ugly:
Too slow-
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

Th B
The Bad:
d
Highly subjective – expert chart analysis required
No adjustment for changes in direction or volatility
F
Frequentt whipsaws
hi in
i sideways
id market
k t

The Ugly:
Too slow-
T l R idl rising
Rapidly i i prices
i quickly
i kl gett too
t far
f away
Not suited to downtrends – where is next stop?
 Exit at Parabolic SAR
The Good:
Accelerate very quickly to keep pace with rising prices

Th B
The Bad:
d
Complicated calculations requiring computer and software
No adjustment for changes in direction or volatility
F
Frequent
t ““whipsaws”
hi ” in
i sideways
id markets
k t

The Ugly:
Nott suited
N it d tto d
downtrends
t d – where h is i nextt exit?
it?
Does not let profits run for big gains
 Exits at SmartStops.net
p
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
gl – SmartStops are beautiful!
 Q
Quick comparison
p
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
highs,
$52,970.

The SmartStops exits improved results over this ten-year

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
p the exits trail at a distance in order to let
profits run.

In a downtrend the exits are moved closer to protect more

capital.

IIn sideways
id markets
k theh exits
i trail
il just
j outside
id the
h range off
random price swings to avoid “whipsaws”.
 How the SS strategies work
22. 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”
True range adjusts for gaps
 How the SS strategies
g work
3. In upward trending markets the “Chandelier Exit”
allows the exits to keep
p up
p with p
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
g work
4. A highly modified Parabolic indicator allows the
stops to gradually accelerate without getting too
close:

The Parabolic
Th P b li is i modified
difi d to
t make
k it a long-only
l l indicator
i di t andd it never
reverses.

The acceleration of the Parabolic is slowed so it does not accelerate too

fast.

Thee Parabolic
a abo c iss modified
od ed so thata it iss not
o aallowed
owed too move
ove inside
s de thee
range of normal price activity.
 How the SS strategies work
5. Combine the exit signals
g with a foolproof
p and
intelligent method of reentering trades after an exit:

Tryy to find indicators such as MACD and ADX that can signal
g 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
S S uses two proprietary
i reentry methods.
h d WhWhen theh trendd is
i
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 clearlyy show that,, in the longg run,, the benefits of usingg
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 reenter if a
strong
g upward
p trend is resumed.
 Ad i Learn “Position Sizing”
Advice:
Use your protective stops to determine your correct “position
position size”
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 $1,500 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
it and
d th
then make
k sure you control
t l your iinitial
iti l position
iti size.
i
 Advice: for Short-term traders
Most of the exits discussed in this presentation work best for long
long-term
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.

 U ATR tto sett profit
Use fit ttargets
t
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).
 Th k ffor attending
Thanks tt di
For additional education and many informative
articles be sure to visit www.SmartStops.net and
www.TraderClub.com.

You are welcome to contact me by email at

Chuck@SmartStops.net if you have any
questions about this presentation or about
SmartStops.

Good luck and good trading!