Articles
Exiting Trades: Profit Targets & Stops
Subscriber question on profit targets & stops …
Got this email from Ron the other day and it states the problem brilliantly:
“Hi Barry, Need to ask if you have insights into the psychology (especially the fear) of trading the Emini? Have studied my trades and notice the following behaviours:
1. When the trade goes my way, I tend to bring my stop in to break even (fear of turning into a losing trade). Often I get stopped out only to watch the trade produce 2-3 points if I had stayed in.
2. I tend to take profits early, in the first leg in my trade. I notice in your videos that you get your 4 points by allowing the trade to pullback, then reach your targets. That is nerve racking for me, again, I believe fear of turning the trade into a loser.
3. My stop is at 1 – 1.5 points, thinking that if the trade goes that far, it is not doing what I thought and I need to get out. There have been times when I have been glad but often I get stopped out only to see the trade move into winning territory.”
Here’s my 2 cents on Exits and psychology. Please bear in mind that the numbers used apply to the Emini market.
The “Magic 4 Points” profit target …
The Emini tends to move in 8 to 10 point trend “legs”. If we’re lucky there are 2 to 3 of these a day – but from time to time we get no volatility and you’re better off not trading at all.
So if the average trend leg is 8 to 10 points – how much of this can you capture? The start of a trend leg will always have some chop, usually around 2 points. Then the end of a move will also have some chop as the market finds a bottom or a top – again, usually 2 points.
What we’re left with is 4 to 6 points of solid trend in the middle of a trend leg. And that’s what I’m trying to capture – the “Magic 4 Points”.
So for me, assuming I’ve entered well – not at an extreme but after the move starts to prove itself – the prudent thing to do is take profits after 4 points. That way I’ve exited while the trend is still moving and traders are chasing the trend, plus I’m not sitting through chop and trying to pick the extreme of the move.
The only exception to my 4 point profit target is on an “Icebreaker” trade. This is my first trade of the day and all I’m trying to get is 2 points. Psychologically it’s nice to be out with a solid 2 points, plus at the beginning of the day the market tends to be range bound and finding the support and resistance levels.
The “Pro Signal” exit …
The highest risk-to-reward exit signal I’ve found is called the “Pro Signal”. The signal is made up of a Professional bar plus nearby Exhaustion volume pattern on the 1,500 tick bar chart.
This highlights an area of support or resistance where Professionals re-enter the market to take profits. Plus with Exhaustion volume the move has temporarily run out of sellers or buyers and so is ripe for a small reversal.
Reversals on the Emini tend to be 1 to 2 points and so rather than sit through this I like to be out, having taken my profits.
Normally, if I’ve entered well, my “Magic 4 Points” profit target is very close to this “Pro Signal” exit – and so I’m happy to be out. If I’ve missed a good entry then I’ll just exit at market as soon as I see the “Pro Signal” – and hope to get 2 to 3 points of profit.
Psychologically I like this exit. I’ve taken profits while the trend is in my favour. I don’t have to sit through a 1 to 2 point retracement. Plus I don’t have to agonize over where the trend move will eventually end. It’s the perfect place to exit a “runner”.
The “Room to Move” 4 point stop loss …
One of the things that differentiates Professionals from Amateurs is the size of their stop.
Amateurs have been convinced that they can trade with minimum risk and only a 1 to 1.5 point stop. This assumes they can enter their trades perfectly and that the market immediately goes in their favour.
Both of these things are fantasy.
The Emini is a volatile market and the Professionals love to shake out the Amateurs. The stops are clustered in such obvious places it’s just plain fun gunning for them. Moves testing and exceeding recent pivot points by 1 point are common – pull up an Emini chart and see for yourself.
So what I do is use a 4 point stop and reduce the number of contracts I trade so that the damage to my account equity from a stopped out trade is minimal (2.5%).
This activity by the Professionals – testing pivot points and running stops – also makes using a Break Even stop a non-starter. Much better to get the trend direction right and just to wait for the “Magic 4 Points” profit target to be hit.
And the “Cute” stuff I avoid …
Trailing stops sound fantastic – maximize your gains by trailing a stop and exit when the trend finishes. Trading books are filled with them: based on ATR or lowest low of last x bars.
Another real life versus “I read it in a book” clash.
If you exit on a trailing stop you’re forced to exit during a retracement – you’ll get slippage and at the end of the day you’ll make almost no more than if you’d exited on the “Pro Signal” or the “Magic 4 Points” profit target.
Yes, occasionally the market melts down or melts up – and a trailing stop results in a 10 point monster trade. But, honestly, day-to-day you’re much better off having a profit target and exiting as the trend is moving – no slippage, less time in the market, less risk and psychologically easier to trade.
Summary: Keep it Simple
So in terms of profit targets and stop loss orders, here’s what works for me:
1. 4 Point profit target
2. 4 Point stop loss (risk-to-reward ratio of 1-to-1)
3. Profit target and stop loss orders transmitted with the entry order (OCA)
4. Exit a runner either at target or when I see a “Pro Signal”, and
5. Don’t forget the “Gut” exit – if it doesn’t feel right, get out and watch.
Good luck with your Emini trading and remember “the trend is your friend” – get the trend direction right and your profit target will get hit, eventually.
Written by:
Barry Taylor
http://Emini-Watch.com
Gold Miners Index May Be Warning Us
The past couple weeks I have been keeping a close eye the price of gold and the gold miners index. I check to see if its pointing to higher or lower prices in the near future using inter-market analysis, price and volume, along with technical analysis. At this time the charts are still pointing to lower prices in the coming days or weeks.
Taking a look at the daily chart of Gold
As you can see it has formed a bear flag with declining volume and the price has drifted up into a resistance level. This combination typically leads to lower prices. With international fears floating around and the fact that inflation has started does make me a little weary of shorting gold but one thing I have learned over the years is that trading on fundamentals and news clips seen on TV is not a reason to pass on a setup if one forms in the coming days. The only thing that pays in the stock market is when the price action goes in your favor. This is why I focus on price, volume and momentum while avoiding what others are saying elsewhere. Trading is a numbers game and I put my money on the table when the odds are clearly favoring one direction. Unfortunately I am trading trades against what the masses think and feel is the right thing to do.
Its Super Gold Sunday!
While Ben Bernanke says we are not seeing any inflation, I think most of us know that is a load of BS as other countries like Egypt see food prices surging. Over the past couple years everyone has been talking about how inflation will soon start and that has been one of the main driving forces for higher precious metals prices.
As we all know the market does the opposite as to what the majority of investors are doing. And while everyone has been buying metals in anticipation of inflation, I find it amusing how inflation for the first time is clearly presented on TV (Egypt issues) and we see gold and silver trading lower than they were a month ago. Seems like the buy the rumor sell the news lives is playing out. But the question everyone is starting to ask is how far will the metals correct?
Do I See Lipstick On A Pig? Or Is The Stock Market and Gold Still Going Up?
As most sophisticated investors and traders are aware, the U.S. Federal government has run up significant deficits and the long term debt burden is becoming a drain on Gross Domestic Product. That being said, most economists are discussing the possibility of a major decline in the value of the U.S. Dollar going forward as inflationary monetary policy begins to strangle growth. While that view point may prove right over the long haul, in the short run most traders are not likely expecting the U.S. Dollar to rally.
The U.S. Dollar is expected to reach a multi-year cycle low in the near future. From the cyclical low, I expect the U.S. Dollar to regain a strong footing and work higher against the crowd. This is not to say that the U.S. Dollar will not eventually decline, but financial markets do not work that easily. Shorting the U.S. Dollar is a crowded trade and Mr. Market punishes crowded trades quite often by pushing prices the opposite of what the heard is expecting. Should the U.S. Dollar find a strong underlying bid, precious metals and domestic equities would feel the brunt force of such a move. While it remains to be seen if the U.S. Dollar rallies, if it does it will catch many traders and economists by surprise and the unwinding of the short dollar trade could unleash a wave of buying that we have not seen for quite some time.
Precious Metals and the Dollar’s Next Big Move
There is a potentially big setup in precious metals sector along with the dollar which looks like its about to unfold. Since mid-October of last year gold started to show signs of distribution selling. Only a month later in November silver started warning us that some big players were taking some profits off the table also. Distribution selling is easy to spot on the charts. In short you will see heavy volume selling accompanied with strong moves to the downside.
Now if we look at the US Dollar chart we see the exact opposite price action. We see sharp rallies during October and November of last year. It’s normal to say that gold and silver move inverse to the Dollar so this price action makes perfect sense.
The interesting thing with the US Dollar is that in Nov-December it rallied breaking through a key resistance level and has been consolidating above support ever since. If this bullish pattern (bull flag) plays out, then it’s just a matter of time before the dollar makes another strong rally upwards, which will put downward pressure on stocks
