Switch Time Frames For Better Exits

I just returned from a weeklong Trader's Camp hosted by Dr. Alexander Elder in a beautiful island nation in the South Pacific called Vanuatu. When I studied geography in school many years ago, Vanuatu was known as the New Hebrides islands. Vanuatu is located about 1,000 miles west of Fiji.

If you have read Elder's excellent book, Trading For A Living, you will recall that Dr. Elder is an advocate of using multiple time frames for trading both stocks and futures. For example, he suggests looking at the weekly chart to make sure that the weekly trend is firmly up before trading the long side of a market based on the daily chart patterns. This approach makes good sense and I highly recommend his book and his strategy.

While listening to Dr. Elder explain his multiple time frame strategy for entries, my thoughts wandered to the application of his ideas to my favorite subject - exits. One of my goals in trading is to find exit strategies that do a good job of protecting open profits. One method of accomplishing this goal is to simply move the daily stops closer once a specific profit objective has been reached. However, it might also make sense to simply switch to a chart with a shorter time frame once we have reached a reasonable profit objective.

Here is an example of how such a strategy might work. Let's say that we have been trading XYZ stock on an intermediate term basis using daily charts. The trade is working out very well and we now have six ATRs of open profit. (See previous Bulletins for an explanation of how to use Average True Range to set profit targets). Up to this point we have been using our well-known Chandelier trailing stop placed at 3 ATRs below the high point of the trade.

However, now that we have reached our primary profit objective we want to tighten up our stop to protect more of our profits. We could reduce our Chandelier stop from 3 ATRs to 2 ATRs and continue using the daily bars or we could switch our chart to one hour bars and continue to trail the Chandelier exit at 3 ATRs based on the intraday one-hour bars. The basic idea is to switch to a chart with a shorter time frame once we have reached our profit objective. This procedure should allow us to let our profits continue to run but we would be protecting our open profits with much closer stops by using the chart with a much shorter time frame.

Combining our exit strategy with Dr. Elder's entry strategy would provide the following sequence: for entries we first examine the weekly chart and then use the daily chart to trigger the trade. Once we are ready to exit our trade we examine the daily chart and then trigger our exit using the hourly chart.

Of course this strategy would require some extra work as well as the use of intraday data. The alternative would be to simply reduce the number of ATRs used to hang the Chandelier exit on the daily chart. Either way we do it, the logic is to move our stops closer once we have achieved a worthwhile trading profit.

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Notes On Bear Markets

One of the best ways to gauge a bear market is to observe the reaction to good and bad news. In a bear market the averages go down even when the news is good. (For example, look what happened the last time the Fed cut interest rates.) We will know that the bear market is finally over when we observe the market reacting favorably to good news. In the meantime, we can take some consolation in the fact that at the present rate of decline we will soon be at zero. At least at that level we should be able to safely resume trading stocks from the long side.