Stop Losses/ Exit Strategies at the Top

Stop Losses/ Exit Strategies at the Top

The other major concern for most investors is where does one start trying to protect profits. The easy answer is, “when you start witnessing sell signals.” That should be the ultimate method. But that does not work for all investors. If the trades cannot be watched at the beginning of trading or the end of each day's trading, a problem that most working investors face, then a stop-loss strategy can be implemented that protects most of the profits. The phrase “most of the profits” has a significance.

Our ego’s have a severe deterrent for allowing us to make money. The majority' of investors feel drat a trend needs to be bought at the very bottom and sold at the very top. To take profits before a trend peaks out or after the high has been seen is a blow to the ego. “Why didn’t I get out when it was a point and a half higher?” the question always asked with a tinge of anguish in the voice. A defeat to the ego if that trade was not maximized to the hilt. The point to maximizing profits is not to maximize the profits from each trade. It is to maximize the profits in the account. Two completely different objectives!

The aspects of the ‘built in’ psychology behind the signals produce immense advantages. Knowing what the normal investor flaws occur in invest­ment actions provides an effective trading strategy Placing stop-losses, based on where a price should not move back to in an uptrend, becomes an easy function. The depiction of human emotions is charted in the price action of the trend. To reiterate, the average investor panic sells at the bottom and is an exuberant buyer at the top. Knowing this (and probably having experience with those flaws in our own previous investing habits) the candlestick investor can be prepped for when a sell signal should be occurring.

What do we see at the top of the trend? Exuberant buying! Buying that is usually shown as larger white bodied candles after an extensive uptrend. Or, a gap up at the top. Being armed with that knowledge permits the candlestick investor to extract a high amount of profit from a trade.

As seen in Fig. 10-11, the Tivo chart, the gap up when the stochastics were peaking out indicated that the exuberance had culminated. The gap up was the signal. What is the best way to exit from this trade? First, the gap at the top is the sign to be ready to sell. A couple of simple stop-loss applications make getting out of a trade an easy mechanical procedure. When the price gaps open in the overbought area, a few things can occur. The price can continue to go up from that point. The price can stay the same, or it can go down. Undoubtedly, these are not earth moving revelations. Fortunately, dissecting what each will do, as far as a candlestick signal indicates produces an easy-to-execute exit strategy. This is where placing stops becomes an excellent mechanical process.

If the price gaps up, the first action should be to place a sell stop at the previous day’s close. If the price gaps up and immediately shows strength, moving higher, place a sell stop at the opening price. What is the rationale behind these moves?

Consider what signals will be created after a gap up move. Closing at or below the open now produces a Shooting Star signal or a Doji/Shooting Star, both sell signals. Even a close slightly above that day’s open will produce a Shooting Star. A close back at the previous day’s close will form a Meeting Line signal. A close half-way down the previous white body produces a Dark Cloud signal. A close below the previous day’s ‘open’ produces a Bearish Engulfing pattern. All sell signals.

If tire price gaps up, the first procedure is to put a sell stop at the previous day’s close. If prices immediately back off from the open price and the ‘stop’ is executed, the probabilities indicate that the majority of the profits have been extracted from a trend.

If the price opens higher and continues to move higher, moving the stop up to opening price becomes more advantageous. If the price moves up, then back down through the open price, the probabilities lean toward a candlestick sell signal forming.

The only bullish scenario that can occur after the price was up and came back down through the open would be to turn around and have the price move back up substantially. Substantially, being far enough up not to create a Hang­ing Man signal. A gap up at the top, whether it opens and continues higher or it opens and immediately retraces, has many more sell signal opportunities versus the continuation of the uptrend. Back to a basic premise, maximize profits for the account. A gap up at the top is now a high probability profit­-taking situation. Be ready to move the funds elsewhere.

Fig. 10-12, Siebel Software is another example of the gap up at the top. A sell stop at the open would have provided a very profitable execution. Not all trades will give you time to place the order at the open price, if upon opening, it immediately moves up and quickly falls back. Tire next safe stop is at the last white candle close, which in this case did not get executed until the following day.

Fig, 10-13, Cree Inc’s chart illustrates another example of the open or the pre­vious closing price becoming the best strategy point for placing a sell stop. This chart reveals the warning signal four days earlier, a Shooting Star. It would have taken a huge up move, after pulling back through those levels, to elimi­nate the possibilities of a sell signal forming. Upon seeing the stochastics in the overbought range and a gap up at the top of the mend, get out. Why try to buck the odds. Take the profits and go to a low risk, high probability trade.