Author: Duane Runnels Date: To: CANSLIM Stock Investment Group Subject: Re: [CANSLIM] exit stradegy
I looked up some old posts I saved by previous masters of this list -- Jeff Henderson and Katherine Malm. Here are their responses to your question.
Stop Loss/Worst case loss:
2) trailing stops
- adjusted on a peridodic basis according to an algorithm. It can be based upon volatility, a moving average, a channel breakout, various price consolidations, etc.
- the important point is that your exit algorithm will continually make adjustments that will move the exit in your favor. That movement might not be profitable but it would reduce your potential loss.
§ When you set a stop loss in the market, you are doing 2 important things: 1) setting a maximum loss (risk) that you are willing to take—refered to as R. 2) sets a benchmark against which to measure subsequent gains. Your primary job as a trader should be to earn profits that are large multiples of R.
§ Criteria for stop loss:
o Assuming that your entry technique is not much better than chance and putting your stop beyond the “noise” of the market
o Finding the maximum adverse excursion (the worst intraday price movement against your position that you are likely to encounter during the entire trade.) of all your winning trades and using a percentage of that as your stop.
o Having a tight stop that will give you high-R-multiple winners, and or using a stop that makes sense based upon your entry concept.
§ Might want to consider an illogical stop loss to the market
§ Average daily true range of the last 10 days ~ daily noise.
o Then multiply the 10-day moving average of the average ture range b/t 2.7 and 3.4 and you’ll have a stop that’s far enough away from the noise. This is a good stop for long-term trend followers.
o A wide stop is not a lot of risk if your position size is small or minimal
§ Good trades seldom go too far against us (the MAE of winning trades will seldom go below a ceratin value). The implication is that you might be able to use much tighter stops than you originally anticipated.
§ Can be used when you’re predicting a major change in the market and the market starts to confirm that prediction.
§ Can also be used when looking at a shorter time frame.
o You will lose much less money when you abort the trade.
o You can make multiple attempts to capture a big move.
o If you get the move it will give you a much bigger R-multiple profit.
o Decrease the reliability of your system. You will have to make many more trades to make a profit. Might affect you psychologically.
o Dramatically increase your transaction costs.
Using a Stop that Makes Sense
§ Dollar Stops
o Psychological advantage (know you know exactly how much you could lose.
o Unpredictability. Also when they are beyond the MAE they end up being good stops.
§ Allows the price to retrace a certain percentage of the entry price
§ This practice is fine if your retracement methods is based upon some sort of MAE analysis. If you just pick a number out of the air then you’re a jackass and you could be throwing away a lot of profit.
§ Based upon the assumption that the volatility represents the noise in the market.
§ Among the best stops you could select according to the author.
Channel Breakout and MA stops
§ Authors opinion is that they are not nearly as good as as stops based opong the average true range or MAE.
§ Both stops and profit taking exits.
§ Channel Breakouts- might place a stop when when prices make a new low for the last 10 days. Has the advanatage of giving prices a lot or room but the disadvantage of giving back a lot of profits because your stop is the worst-case protective stop and your profit-taking stop.
§ The idea that if a position doesn’t go in your favor fairly quickly then it will probably not.
§ If you have a meaningful entry signal then this is useful if you aren’t making profits
§ Very subjective choice.
§ Not to use if you’re a long term trader
§ Excellent addition to an arsenal if you are a short term trader
§ Can pick a 3 day stop or just monitor position every day. Evaluate them after you use them
Moving Average Crossover
§ When the short average crosses the longer
§ Problem- you could get whipsawed all the time.
§ 3 moving average system-when the shortest crosses the medium you get out. You wouldn’t go short until both the medium and the short cross the longer average.
§ Fairly tight stops for short-term traing- be right about 50%-60% of the time
§ 3 or 4 different exits
Discretionary and Psychological Stops
§ Discretionary not recommended for beginners
§ Psychological is great for most people. Ex: You stop because there is a death in the family or something like that.
How to take Profits
Exits that Maximize Your Profits
§ Trailing Stop
o The volatility trailing stop is a multiple of the daily volatility of the market. Suggests that it should be a number between 2.7 and 3.4 times the average true range of the last 10 days. If you use the weekly volatility then you probably should use .7-2 times the weekly volatility.
o Dollar trailing stop- should be adjust for what is reasonable for each market. The best way to check is to look at the volatility so you might as well use a volatility-based stop.
o Channel breakout trailing stop- this is when you decide to get out at the extreme price of the last X days. Thus, in a long position you might decide to sell if the price hits the low of the last 20 days. This is quite useful.
o Moving Average trailing stop- You have to determine the number of periods involved. For example a 200-day moving average would keep you active in the stock market over the last 3 years. Not to mention the different types- exponential, displaced, adaptive,etc. He really seems to like adaptive methods. Look on page 268 for details.
o Consolidation or chart patterns- every time the market moves beyond a consolidation pattern, that old consolidation pattern could become the basis of a new stop.
§ The Profit Retracement Stop
o Assumes that you must give back a percentage of your profits in order to allow them to grow. In order to use this you need to meet a certain level of profitability such as a 2-R profit.
o You use a percentage of your profit for you exit
o As your profits are higher and higher you might want to reduce the percentage
Exits that Keep you from Giving too Much Profit
§ The Profit Objective
o Elliot Wave
o You might decide that 4R is a good milestone for taking a profit or when you get there you might want to use a closer stop
§ The Profit Retracement Exit
o Reread profit retracement stop
o An excellent idea
§ A Large Volatility Move Against You
o One of the best exits
o Also used for entry
o Keep track of the average true range. When the market makes a large move against you, you exit the market-say 2 time the daily volatility.
o In this system you would need another exit such as a protective stop or some sort of trailing stop.
§ Parabolic Stops
o The parabolic curve starts out at a pervious low point and has an accelerating factor in upward-moving markets. As the market trends, it gets closer and closer to the price.
o It does a great job of locking profits but it is quite far from the actual price at the beginning of your trade. Also the stop can sometimes come a little too close to the prices and you can get stopped out while the market continues to trend.
o You can work around this by adjusting the acceleration factor of the parabolic stop to rise faster or slower compared witht the true prices of the market.
o You could also set a different dollar stop at the beginning of your trade. You might also want to consider reentry techniques with this stop.
1) At the time of your buy you have an ATR for that day. You take the
ATR and multiply it by 3 and 2 everyday. Then you subtract it from,
initially, the price you bought your stock and subsequently the close
EVERY DAY. This is important because sometimes the price of the stock
will go down, but the volatility of the stock (ATR) will go down enough
so that you actually move your 3* ATR up.
Now you should know how to use the ATR. Remember recalculate it
everyday and subtract it from the close. This gives you your exit
price. You should only move this price up, never down.
2) For the 2*ATR, calculate this everyday and subtract it from the
close. This can up or down-- it doesn't matter.
3) Now that you know the rules for each, compare them everyday and use
the higher one.
So, at 2xATR, the stock price is 19. At 3xATR, the stock price is at
At time t+1, the stock is trading at 18.7. Since this is not below the
3xATR, it means that we should not sell the position. NO YOU MUST
RECALCULATE IT AGAIN. THE ATR CHANGES DAY TO DAY. IF THE ATR AT T+1 IS
STILL 0.5 THEN YOU ARE CORRECT.
At time t+2, the stock trades at 21. How is the 2xATR use now? What
I do with the 3xATR? Should I move it up? RECALCULATE BOTH AT T+2 GIVEN
MY RULES AND USE THE GREATER OF THE 2.
I hope this helps!
I think you might be confusing the use of the 7-8% rule. You have to think of a stock in several stages for this to make sense:
(1) The stock forms a valid intermediate term base (cup with handle, flat base, double bottom, etc.). It sets up and breaks out above the pivot on volume >=150% of average daily volume (ADV). Assume you enter at the optimal buy point ($.10 above the pivot). Your purchase price is "just right" and this is where the 7-8% rule applies. That is, a stock which is still healthy shortly after a breakout will tend not to fall more than 8% below the pivot before it continues to rise. If you buy at the optimal buy point, then you can then set an inital stop which is not only 7-8% below your purchase price but also 7-8% below the pivot itself. That's the very reason why you don't want to chase a breakout too far past its pivot. If you purchased, say 10% above the pivot, the stock could fall to 8% *below* the pivot and still be healthy. If you also set your stop at 8% loss from your *purchase* cost, you will be shaken out for no practical or technical reason.
(2) Once the stock starts moving up, then you need to decide where your stop will be. There are many guidelines for this, but don't mistake a *price drop* of 7-8% from one day or week to the next as a reason to get rid of the stock. Instead, you want to look at the price/volume action of the stock and determine if it remains *healthy.* For example, after a breakout, say the stock rises very quickly to >=20% above the pivot. This is considered strong follow-through and is often the sign of a stock that has real power. However, it isn't uncommon for a stock which rises 20% or more very quickly to fall back a bit on low or fairly low volume. Why? Because the short term traders get in and quickly take their profits and ride into the sunset. However, as a CANSLIM investor, you're looking for stocks that have the wherewithal to withstand this sort of short term correction. What will most often happen once the short termers influence the stock to slightly lower
prices will be the intermediate to longer term investors coming in a scooping up more shares. That's why you want to stick with it....you're riding the stock for bigger gains. As to your trailing stop, you may simply raise your stop to breakeven at that point. In other words, you really don't want to take any loss on a stock that has risen >=20%, but you also don't want to be whipsawed out of a perfectly good intermediate term position simply because of a temporary pullback. That's very often what sets the stock up to launch further.
(3) As the stock rises, you want to look at the price/volume action itself for any signs that the stock is in *big* trouble. These sell rules (see the investors.com site) are much more subtle and take a lot of practice. You may wish to move your stop up a bit as the stock works its way up, but be very careful, once again, not to set it too tightly. A stock can and does remain perfectly healthy, rising and falling, rising and falling, while the underlying trend itself remains *up*. You want to stick with these winning stocks as long as the price/volume action is healthy. Whatever you do, don't set some arbitrary trailing stop at 7-8%, because it will have absolutely no technical meaning to the behavior of the stock itself. Look for logical support areas such as a trend line, a previous area of support, etc. (Again, you can find a lot of info on this at the investors.com site.)
(4) At some point, the stock will stop its general upward trend and will put in a fresh base. You have several options here. First, you can ride out the consolidation and stay in the stock as it breaks out again. If it fails from the area of consolidation, you can sell. You can add to the position as it breaks out. You can sell as it starts the consolidation. Remember that an intermediate term consolidation can be as little as 10-15% (flat base), to 20-60% for a cup with handle. Your decision to stay with the stock will be determined primarily by the underlying health of the market itself, the underlying health of the stock's industry, the underlying attractiveness of the business itself, and you personal profit taking goals.
All in all, you can't make a general statement about what one *should* do with a stock. You have to decide what you are *going* to do *before* you buy the stock.
--- On Sat, 11/15/08, mxp <mxp2@???> wrote:
From: mxp <mxp2@???>
Subject: [CANSLIM] exit stradegy
Date: Saturday, November 15, 2008, 3:26 AM
you brought up the subject of exit strategy I mean the fact i didn't have one. It would be good to hear about that subject.