Tharp's Thoughts Weekly Newsletter
: Multiple Exit Rules — Exit Strategy
by Sam Eder
: Early discount ends next week for Forex and Bear Workshops in May
: Three Visuals That Show the Aging Bull
Still has Room to Run by D. R. Barton, Jr.
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Multiple Exit Rules—Exit Strategy
by Sam Eder
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“Don’t think about what the market’s going to do; you have absolutely no control over that.
Think about what you are going to do if it gets there” — William Eckhart
After you get into your trade, very rarely does your position go in a straight line to your profit objective. Instead, different things happen.
So, if you only have one tool in your toolbox, you will struggle to react effectively to all of the different outcomes that can happen in an open position. If you only have a hammer, you’ll treat everything like a nail - even when your trade screams for a screwdriver or a measuring tape.
Instead, plan on packing your trading toolbox full of different tools for different scenarios. That way, when the moment calls for it, you can make the right decisions appropriately about when to stay in a trade or when to exit and how best to exit. I learned about the benefits of using an exit strategy with multiple rules at the systems development workshop I attended with Van and RJ in Sydney, Australia.
Here is my take on the subject along with some charts to demonstrate possible scenarios.
Role of Individual Exit Rules
Your trading plan should note specifically when and how each exit should be applied for each trading system. I am talking about exits in the context of a “rule-based discretionary” trading approach. These exits allow you flexibility over the strict execution of mechanical system rules but they are not to be applied on whim.
Furthermore, each exit rule for your trading system should be in harmony with the objectives of your trading system. Each exit type rule exists to achieve a specific goal for a trade and not every type of exit is applicable to every trading system.
In practice, using multiple exits has proved very valuable for my trading and it is probably one of the easiest ways to improve trading system performance. I just wish I had spent more time on this area earlier in my trading career instead of beating myself over the head looking in vain for the Holy Grail entry.
In general, you will want to think about having the following nine types of exits at your disposal for your system’s exit strategy:
1. An exit if the trade reaches your profit objective
2. An exit rule in case of reversal right after entry
3. An exit rule for an intra-trade drawdown
4. An exit if the trade moves steadily in your favour and then reverses
5. An exit for a fast moving market in your favour
6. An exit for a fast moving market against you
7. An exit for when the price gets close to your profit objective and then starts to fall away
8. An exit rule for chart patterns that signal reversals
9. An exit rule if fundamental or sentiment conditions change
Yes, sometimes your job as a trader is to do nothing at the moment but even at those times, you should have planned out what you will do with the trade in various scenarios that will arise.
Simplicity vs. Complexity
Van stresses the importance of simplicity (vs. complexity) in trading. Evolving trades, however, produce far too many different circumstances to let you be effective with just one reason (simplicity) to exit a position. Instead, it’s better for you to understand the multiple possibilities and reasons why you would get out of a trade and then create a set of clear rules for those reasons.
Your intent with your exit strategy is to manage risk and protect your profits depending on what the market does even though this implies complexity. Luckily, Van allows for two exceptions to his simplicity standard - one of which is exits. (The other exception is position sizing strategies.) Each individual exit rule on its own should be quite simple yet combining together many simple exit rules may form a complex exit strategy which helps your trading system more effectively meet its objectives.
Think: When the price action changes, you need to be ready to change your reason (and rules) for exiting a position.
The Market Is Going to Force You to Make Decisions
Throughout your trade, the market is going to throw you all sorts of different scenarios.
It is constantly going to force you to make decisions about what to do. Often, it will be best to sit tight and do nothing, but there will be times when action should be taken. It is at each of these “decision points” that your complex exit strategy comes into play. You will need to assess the current market, your position, and apply the right tool for the job to manage your trade properly.
A decision point could arise for multiple reasons — an “important” price may get hit, a reversal pattern forms, the price reverses some number of R-multiples, and many more. For each situation, you need to decide if you are going to stay in the trade or if it’s time to exit completely or simply reduce the size of your position. Be aware of all of the decision points you are going to face and have rules written about how to act when they do.
Consistently following well defined processes will help you create a consistent set of results and allow you find ways to improve.
Trading effectively what’s in-front of you is all about being prepared.
Let’s look at various exit types and possible rules you might want to have at your disposal when you reach possible decision points.
When your trade hits your profit objective you have a number of options including:
• Set a set profit target price where an order automatically closes the position
• Tighten the stop loss and let the position run
• Take off some of the position and let the rest run
• Make no changes and continue in the trade
• Wait for a reversal signal
Striking some balance between letting profits run and locking in gains very much depends on your objectives, your trading style and your personality. Always remember a primary guideline — let your profits run as much as possible.
A useful profit objective can be a resistance level such as an old high because the chance of the price reversing increases once it hits this level as broad profit taking often occurs there. You could also use a Fibonacci level or pivot point. Most important - have some logical profit target and some rules about what to do if price gets there.
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One of the cardinal sins that amateur traders engage in is letting winning trades turn into losing trades. To stop this scenario from happening, you can apply a maximum intra-trade drawdown rule, or a maximum amount you are willing to give back in order to achieve further gains.
Generally you would select a maximum R-multiple you are willing to give back. For example, if you have a +5R profit, you may institute a trailing stop of two or three times your original risk amount so that you lock in some of your profits while allowing the position to continue in the profitable direction. Note - if you are going for a large profit objective, you may need to be prepared to give back more multiples of your risk than if you are going for a more conservative profit objective.
Six Other Exit Types
We will continue next week in Part 2 of this article examining the remaining six exit types you can consider adding to your trading system.
About the Author: Based in New Zealand, Sam Eder trades currencies using rule-based discretionary systems. He has studied Van Tharp’s trading principles extensively over the last 10 years and incorporates many of those when writing his daily blog posts on his Forex signals service FXRenew.
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Three Visuals That Show the Aging Bull
Still has Room to Run
by D. R. Barton, Jr.
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Have you heard lately about how old this bull market is getting? I’ve been hearing about it plenty for quite a while now. A quick Google search shows a plethora of articles on the topic dating back to 2013.
And yet, this market just doesn’t want to go down - at least not for long. In fairness, it hasn’t made much headway in 2015. But the flipside of that coin is that the S&P 500 index has spent almost the whole year within a few percentage points of all-time highs.
Two charts and a data table really caught my attention this week as we contemplate whether this decidedly mature bull market can keep floating to new highs. Let’s take a look at each of these and then draw some conclusions about how to think about longer-term money.
Just How Old Is This Bull Market?
Periodically, Bespoke has been updating the age of our current bull market. So for our first visual, we have a treat for the data junkies out there. (For Van and those other Neuro Linguistic Programming folks — this visual is for the “audio digitals”). Bespoke defines a bull market as a rise of 20% preceded by a peak to trough pullback of 20% (all data on a closing basis). The data set on the right shows bull markets in chronological order form oldest to newest, while the one on the left (framed by blue) shows the bull markets since 1927 ranked by duration.
We see that the current bull is already the fourth longest of the last 90 years, and within the next couple of months will move into third place. So while the bull has some years on it, it is a long way from being unprecedented in its duration.
Gallup on Finances
Every year, the good folks at Gallup ask a binary poll question about overall finances. This year, here’s part of their analysis from the news release:
“A majority of Americans, 52%, say their financial situation is “getting better,” the highest percentage to say this since 2004. It is also the first time since the recession that this sentiment has reached the majority level.
These data are from a Gallup’s annual Economy and Finance survey, poll conducted April 9-12. The percentage of Americans saying their situation is getting better rose nine percentage points from last year.”
And the accompanying chart:
In the long run, this will most likely be a contrarian indicator. But if you look at the previous higher level in 2004, you’ll notice that we didn’t hit a market top for another three years. So while we’re at an 11 year high in financial satisfaction, this is a very long term contrarian indicator.
The Troops Are Still Following the Generals
My business partner, Christopher Castroviejo, is a veteran Wall Street insider. One of the sentiment indicators that he got me in the habit of watching many years ago is the cumulative advance-decline line or cumulative breadth. As the header infers, this gives us a useful indicator of whether there is broad-based participation in a move or if there are just a few stocks or sectors pushing the market higher while others lag. Let’s look at a monthly chart showing the cumulative breadth vs. the S&P 500 cash index.
By this measure, there are not any signs of declining participation. A classic topping pattern would involve a modest pullback in the S&P followed by a push to new highs, with lagging or divergent breadth.
Our bull market is already one of the longest-running of the last 90 years. And with monetary liquidity still pouring in from Europe, Japan and China this bull could have at least one more big push to upside.
Your thoughts and comments are always welcome — please send them to drbarton “at” vantharp.com — I always enjoy hearing from you!
About the Author: A passion for the systematic approach to the markets and lifelong love of teaching and learning have propelled D.R. Barton, Jr. to the top of the investment and trading arena. He is a regularly featured analyst on Fox Business’ Varney & Co. TV show (catch him most Thursdays between 12:30 and 12:45), on Bloomberg Radio Taking Stock and MarketWatch’s Money Life Show. He is also a frequent guest analyst on CNBC’s Closing Bell, WTOP News Radio in Washington, D.C., and has been a guest on China Central Television - America and Canada’s Business News Network. His articles have appeared on SmartMoney.com MarketWatch.com and Financial Advisor magazine. You may contact D.R. at "drbarton" at "vantharp.com".
Realization: Why I Trade
Rudy van Eekelen
I finished my bachelor of chemistry in 2011 at the age of 22. I started working at a laboratory of one of the biggest companies in the Netherlands. After about 2 years of working I started thinking “Is this it? Is this what I am supposed to do the rest of my life? Working for a living?” I loved my job, but realized that there was more to life than just working. There are more things I should do with my life. Within a year of my career I started to study for my other job, fire fighter. I wanted to do something for the world, as it had already given me so much. After almost two years spending almost every evening next to my regular job in education, I graduated and started with the local fire department. At that point I felt like I was in a hole. I suddenly had so much spare time even though I was working 40+ hours a week. I had the urge to do something new. At the same time I realized I was making good money with my job compared to my friends who were around the same age. I was saving a lot, but had no idea what for. I felt that I should do something with it. I looked into investing it, and that was the start of my trading journey.
I started in the beginning of 2014. Investing in gold/silver, because I read that it had dropped over $500 in the last 2 years, and it had to get up at some point due to the fact that the industry would require more gold for products like mobile phones and computers over the next decades. I opened an account where I could buy gold and silver in different vaults over the world. I spent half of my savings in that account and bought as much as it would let me. After 2 days I was up €100 and thought: this is easy money! The next week though was less fun and excitement as I saw my profit vanish. I thought “I need to learn more”. So I got everything out of my account and started on my first ever trading book. It was a Dutch book “Lerentraden” (in English “Learn to Trade”) by Steven Anthonis. Surprisingly enough the first half of the book was only about psychology. Even though this was not what I was expecting, I continued and read the entire book twice to make sure I understood the technical details. I saw a big potential in technical trading (the last part of the book). I soon found myself opening an account with an online broker. I was able to use all my new knowledge about moving averages, RSI and MACD. Again starting with half my life savings I opened my first trade. I saw a signal at the USD/CHF and bought it. With a leverage of 1:400 it didn’t take long for the trade to be €200 in profit. This much money in a few hours was even easier than with the gold/silver! Then it dropped. Oh well I thought, my technical market analysis was perfect at first, so it probably still will. I’ll leave it on. Then the fear set in. The trade went down and down to the point where I was not able to emotionally handle it anymore. I took it out with just over €40 profit. Even though this was a profit and still good money compared to just saving, it did not feel positive.
Over the next few months I learned to lower my size, but continued to trade more often. I started trading on my mobile phone and was continuously looking. I traded during breakfast, during sports, during work, during my evenings at the fire brigade, during parties with friends. I had no focus on the rest of the world, only on my charts. I was losing, but was excited. I got help from an online trading coach who gave me numerous of great tips. Most of them I already read in my book. Somehow I did not listen, and the stress became more and more. I kept losing and was down 15% of my account. I totally lost my mind. Then in September 2014 I saw a flag pattern on the 5 minute chart in the DAX. I never traded that kind of signal, but gave it a shot. It won, and it won big. After that trade I had 2 more trades, and that got me back up to a breakeven. At that point I decided “I am getting out of this game, it is too much for me right now.” My trading coach was surprised. “Why quit when you are finally winning?” My gut feeling (later to be realized as my Higher Power) was stronger and I got out of my account, and stopped looking at charts for weeks. Slowly my interest in trading faded. I had a feeling I would start again someday, but not now. It was time to focus on work, my relation and myself again.
In November my manager at work advised me to do a mindfulness workshop; because there was little work at the time, and that stressed me out (I can’t stand having nothing to do). This changed my life. At first I was skeptical about these “tree-hugging people”. But my first ever 10 minute meditation was amazing. I gave in to it and felt so relieved. I continued after the workshop by attending a meditation group. Within a few months my mind got back to rest.
Then in February 2015 I watched a webinar on trading. It got my interest again, and was excited to start again with a better attitude and more knowledge than ever before. I gave myself more time to study and planned to read more books and watch more webinars. I looked for a top 10 list of good trading books. As I scrolled over the pages I recognized a name that I read in my first book: Van K. Tharp. The book “Super Trader” sounded like a good book. After reading it my view on risk management and position size changed completely and I was hooked by the statistics you can get from your system. I loved the book so much that I ordered another book of Tharp's just before I finished “Super Trader”. This book was “Trading Beyond the Matrix”. When I got the book I took a quick look at the pages and found out there was little about technical trading or statistics. Even though I was a little disappointed, I trusted Tharp for it to be a good book and start reading. Most of the time I read during my train trips on my way to work.
My impact came after chapter 5: Beliefs. On my bike from the train station to work the question popped up in my mind “Why do you trade?” After thinking about it I realized I am not actually trading for the money. I have a good job, so I don’t actually need more money. Then why? I started asking myself questions, and running thoughts and beliefs trough the Belief Examination Paradigm. I was also holding parts parties in my head and on paper during my train trips. After multiple exercises it hit me. I am actually trading because I learn a lot of important life lessons from it. Trading helps me get to know myself. It helps me think about why I believe things and why I do things.
On the side trading provides me with the opportunity to make extra money. The money does not interest me that much anymore (compared to the point where I started) as I realized I am not in real need of it. What it does though is that it buys me potential time. I realized I don’t need money to be happy. But money can buy me time in the rest of my life to do things that actually do make me happy such as teaching children, volunteering and helping at the fire brigade.
Chapter 5 starts with a story about a little boy who wanted to talk to his just born little brother to ask him “Please tell me about god, I am starting to forget.” Within the next hour after reading it I felt I had deep contact with my higher power. It is something that I seem to not have felt since my first few years of my life. On my bike from the train station to work I started crying for no reason. Just that sentence in my mind: “Please tell me about god, I am starting to forget”. The feeling was so intense, but at the same time so good! I felt that I was able to connect again to my higher power. This book has taught me more valuable lessons than I could ever imagine.
“Trading Beyond the Matrix” in combination with meditation helped me to realize who I am, and who I want to be. It gave me purpose in life, be happy. I am grateful to Dr. Tharp that. He helped me find out this purpose at my age.
I am looking forward to continue exploring my Self. And with the help of the Van Tharp institute I am convinced that my journey has just been started.
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April 22, 2015 #730
Van's Top-Twelve Favorite Trading Books
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