Winning Exit Strategies: 2 Red Candles

Ken Calhoun |

how to take profits in stock market, when to take trading profits in stocks, profit taking stocks, exiting profitable trades, how to trade stocks

In our earlier articles we’ve focused on how to identify strong intraday and swing trading entries. In this article series, we will look at how to exit trades more carefully, to lock in gains and minimize stops.

The good news is that it’s relatively easy to spot when to exit a trade, once you know what specific visual chart patterns to look for. Figuring out when to exit a winning trade has been a common challenge for active traders worldwide; the key is exiting with an early profit before the market takes it back.

Swing Trading Exit Strategy #1: The 2-Candle Red Reversal Pattern

When swing trading, it is often helpful to look at a 90-day daily candlestick chart, in addition to a shorter-timeframe chart, to help identify key support/resistance levels. A favorite momentum exit pattern is to exit a long swing trade on any day after 2 daily red candles have appeared.

Two “red candle days in a row” is an indication that the earlier long trend has likely been broken, or has stalled and may sell off. The exit signal is 1 point under the low of the 2 red candles.

For example in Figure 1, GoPro, Inc. (GPRO) , following the strong long uptrend, 2 red candles appeared on September 29th and 30th, one after another. This is an exit signal, in which a sell order would be placed one point below the low of the two red candles (near $85).

 

Figure1_GPRO.gif


Contrary to the “buy pullbacks in an uptrend” largely losing methodology that inexperienced traders may have struggled with, this simple visual exit strategy uses price action to indicate when a sell signal occurs. We look at drops in price as often being a trend reversal to sell into, not a buying signal.

Two red days in a row is often a strong reversal signal. This type of approach is especially helpful when there are no classic obvious candle patterns, such as shooting stars or bearish engulfing candles to use in determining an exit following a successful long breakout entry.

Pattern #2: Declining Candle Heights with 2 Red Candles

Another pattern to look for is one in which the candle body heights decrease in size during a sharp uptrend, followed by 2 red candles.

This pattern is illustrated in Figure 2, Direxion Daily Energy Bear 3x Shares (ERY) ; as you can see the 2 red candles were followed by a sharp drop, following the earlier uptrend. Exiting an open long was indicated at a point $1 under the two-candle low, near 19.7 in this example. The sharper an instrument moves up, the more prone it is to subsequent reversals; by looking for these two-candle patterns an astute active trader can exit early to lock in a gain and/or minimize stop loss costs.

 

Figure2_ERY.gif

 

It’s often helpful to look at the candle heights (and colors) as visually telling a story of supply and demand. By focusing on the price action in the daily candles, early breakouts and reversals can be spotted in time to make smart trading decisions.

Pattern #3: Sharp Explosive Breakouts and Reversals with 2-Red Candle Pattern

In the excitement of trading a particularly strong momentum breakout chart, traders are often dismayed when what had “looked good at the time” for a long entry immediately reverses downwards. Using the 2-red candle approach can help traders time their exits like professional traders, once the pattern is learned correctly.

In Figure 3, Lakeland Industries Inc. (LAKE) this strong breakout reversed course sharply, traveling from $6/share to $29/share then back down to near the midpoint at $13/share. Visually looking for 2 red candles, it is obvious that a loss of $21, the 2-candle low, was the right place to close out an open long trade.

Figure3_LAKE_1.gif

Spotting these reversal patterns can help traders exit “on time”, near a clear pivot, before the chart continues to drop. This strategy is also especially useful in intraday trading as well, which will be covered in an upcoming article.

Recommended reading: For more on candlestick charts, learn from the world’s foremost authority and author’s colleague Steve Nison, in his book “Strategies for Profiting With Japanese Candlestick Charts (2011, Wiley Trading). For more on using this pattern, see the author’s complimentary Saturday “Trading Week Ahead’ webinar events at DaytradingUniversity.com/free.

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.

 
 

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

Companies

Symbol Name Price Change % Volume
GPRO GoPro Inc. 9.70 -0.12 -1.22 3,398,923
LAKE Lakeland Industries Inc. 11.45 0.10 0.88 24,612

Comments

Emerging Growth

Naked Brand Group Inc

Naked Brand Group Inc through its wholly-owned subsidiary is engaged in manufacturing and selling of direct and wholesale men's undergarments to consumers and retailers.

Private Markets

8tracks

Our mission is to be the best place for people who care about music to create and discover thoughtfully curated playlists. In essence, 8tracks is a platform for online mixtapes.

Dropbox, Inc.

Dropbox is a service that allows their users to bring all photos, docs, and videos anywhere, and share them easily. Any file saved to Dropbox will automatically save to all…