Every successful trader and investor I've encountered over my years in the financial industry has one key trait in common: they know how to admit when they're wrong. Let that sink in for a moment.
The ability to recognize and accept when a trade or investment isn't working out as planned is crucial for long-term success in the markets.
As a technical analyst, I firmly believe that charts hold the key to making informed decisions. Learning to read and interpret charts is relatively straightforward; the real challenge lies in actually following through with what the charts are telling you. This is where the concept of risk management and exit strategies comes into play.
Approaches to Exit Strategies
There are three primary ways to think about stops or exit strategies from a technical perspective: a correction in price, a correction in time, or something more advanced based on factors like volatility. Most approaches fall into the first two categories, with price-based stops being the most common.
Price-Based Stops
The simplest form of a price-based stop is a percentage stop. Take the legendary investor William O'Neil, for example. He advocated for a flat 8% stop, meaning that if a position moves against you by 8%, you exit without question. This approach is effective because it's easy to understand and follow, and it helps limit losses. Remember, all large losses begin as small losses.
Using Technical Levels as Stops
Another price-based approach is to use specific technical levels, such as swing lows or Fibonacci retracements. By placing a stop at a recent swing low, you can ensure that your position remains intact as long as the uptrend continues. Fibonacci retracements, like the 38.2% level, can also serve as potential exit points if the price breaks below them.
Moving Averages as Exit Signals
Moving averages, like the 50-day or 200-day, are also popular among technical traders. If a stock that has been in a consistent uptrend falls below its 200-day moving average, it may be time to consider exiting the position.
Advanced Price-Based Stops
More advanced price-based stops include indicators like the parabolic SAR system or the chandelier exit strategy. The latter, developed by Chuck LeBeau, uses average true range (ATR) to adjust the stop dynamically based on volatility. As the price moves higher, the stop is bumped up accordingly, helping to lock in gains.
Time-Based Stops
Time-based stops, on the other hand, focus on the duration of a trade rather than the price movement. If a position hasn't moved in the expected direction within a certain number of price bars, say 12, it may be time to exit. This approach, popularized by Tom DeMark, is based on the idea that if a signal hasn't played out as anticipated within a specific timeframe, it probably wasn't a great signal to begin with.
Listen to the Charts
Ultimately, the most important thing is to listen to what the chart is telling you. As Justin Mamis once said, "If the stock isn't doing what you expect it to do, sell it." Technical analysis is about identifying patterns and configurations; if the chart indicates that your thesis isn't working out, it's crucial to acknowledge it and act accordingly.
The key to successful trading and investing lies not in being right all the time, but in knowing when to admit you're wrong. By employing a well-defined exit strategy, whether based on price, time, or a combination of factors, you can effectively manage risk and preserve capital. Remember, the markets are always sending signals; it's up to you to interpret them and make informed decisions based on what the charts are telling you.
RR#6,
Dave
Disclaimer: This blog is for educational purposes only and should not be construed as financial advice. The ideas and strategies should never be used without first assessing your own personal and financial situation, or without consulting a financial professional.
The author does not have a position in mentioned securities at the time of publication. Any opinions expressed herein are solely those of the author, and do not in any way represent the views or opinions of any other person or entity.