Given the recent record-breaking new highs in our markets, it’s time to consider how to lock in profits for open winning swing and position trades, before the market drops. In this series of articles, we’ll look at how to use easy-to-follow trade management tactics designed to help traders get out of trades at the earliest signs of weakness. The goal is to scale out of trades in two exits, like industry professionals do, so that profits are realized at two sequential price regions.
Scaling Out Of Winning Swingtrades: Your 2-Step Exit Plan
As markets continue to rise and share prices climb, it’s a smart idea to lock in gains before the market takes back a large part of unrealized open profits. New traders often miss out on breakout rallies, only to buy near a top, entering too late. Or they stay in winning open positions far too long, using trailing stops that are too far away, needlessly sacrificing unrealizing profits during market reversals and broken trends.
An old Wall Street saying is that “markets take the stairs up, and an elevator down”. Meaning, as we’ve seen in the S&P and NASDAQ markets, the first few months of 2013 have been characterized by a strong, steady slow climb. When markets sell off, they will do so with a much sharper price action drop, as evidenced from the 2008 market drop, which occurred relatively quickly.
Now it a very smart time to start locking in profits by exiting half of open swing (or position) trading longs, at the first sign of weakness in whatever instruments are being traded. It’s important to “trade markets first, stocks (and ETFs) second”, which means look for key support and resistance levels in the S&P and use those to help decide when to stay in, when to add to winning trades, and when to start exiting open winning swing trades at the first sign of market weakness.
In Figure 1, $SPX (S&P 500 Index), we use a 4-day and 8-day low as major S1 and S2 levels, respectively. Therefore we look to start scaling out of open winning swingtrading longs if the S&P loses 1645 support (for half of open positions), and close out remaining open longs if the S&P loses 1620 support.
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The thinking behind this professional trade management strategy is twofold. First, we want to lock in gains at a minor market reversal (if the S&P loses a trailing 4-day low level, in this case that’s 1645). However we still want to keep some open shares remaining, in case the market consolidates and then continues upwards. So the second scale-out level, S2, is at 1620. This is used for all open swing and position stock and ETF trades, as a decision-making tool.
Moving forward, look for similar 4- and 8-day lows to help decide where to potentially exit open winning trades, to lock in gains before the market takes back profits.
A wider range day is one in which the day’s high-low range is at least 30% wider than the prior day, as you can see in this example (1 point for a regular range day, compared to 1.5 points on a wider range day). Entry signals are generated just above this day’s high, for a continuation breakout swing trade, using a 1-point initial and trailing stop, for an entry signal 4/24/2013.
Momentum Exit Signals: Swing Trading Using 2-Day Highs and Lows
In addition to using the broad market’s 4- and 8-day support levels to help guide trading exit decisions, it’s also helpful to exit trades with momentum exit signals. For stocks priced $50-$80/share, a trailing partial stop at $1.5 (one and one-half points) below the current day’s low can be added, to help decide scale-out decisions as well. This would be a first place to consider scaling out of an open winning long, the 4- and 8-day lows can be added as well, to help decide how to exit.
In Figure 2 Tesla Motors, Inc. (TSLA), we’ve marked out the 4-day low at $78 and the 8-day low at $64. If a trader has been in an open long from the earlier breakout region, in the $54-$62/share area, for example long 400 shares, it would be prudent to scale out of half the open winning long (200 shares) if price dips below $78/share, to lock in a gain, and the remaining open shares if it gets back below $64 per share.
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This dynamic approach to scaling out of open winning longs helps accomplish two important goals; namely to lock in some profit at the first sign of a pullback or trend reversal, plus staying alive in an open winning trade during consolidation or minor pullbacks in an uptrend that can continue upwards. Experimenting with different scale-in and scale-out strategies is the hallmark of a solid trader; it makes sense to not have “all or nothing” approaches to trading, but rather to incrementally add to and subtract from trades in accordance with price-action breakouts, consolidations and pivot regions.
Creating a Smart Trading “Exit Action Plan”
It’s easy for traders to get caught up in individual charts, and pay only secondary scant attention to the major market’s action. Yet it’s precisely using the S&P 500 (and NASDAQ) key support and resistance levels that are most important, since they reflect institutional big-money inflows and outflows.
Putting your trades in context, to both protect open winning profits as well as exiting at the first sign of trouble, is how to optimize a professional retail trading approach. It’s also important to use specific candlestick chart patterns (such as doji, shooting stars, engulfing patterns and others) on the daily 90-day S&P chart to help guide trading decisions. We will cover this and other important topics in upcoming articles. The first step is simply to decide 2 price points at which to trail hard stops on open long swing trades (and position trades), to exit trades in two portions, instead of all or nothing.
Developing a smart action plan to exit open winning trades early and often can also help traders identify smarter, more flexible ways to manage both their entries and exits. We’ll also look at additional specific elements of what goes into a smart trading “exit action plan” in our next article.
Ken Calhoun is a trading professional who has traded millions of dollars of equities since the 1990s, and is the producer of multiple award-winning trading courses and video-based training systems for active traders. He is a UCLA alumnus and is the founder of TradeMastery.com and DaytradingUniversity.com, popular online educational sites that reach tens of thousands of active traders worldwide.