One of the most important concepts in trading is that you need to let your winners run. It means that you need follow the trend, and you need to stay in the trade as long as the trend does not change.
But how do we know when the trend reverses? How do we avoid getting out too early, but also giving back most of our profits? The most common solution is to have a trailing stop, that moves with your position. In the swing trading virtual portfolio we very often use the 5MA as a trailing stop: if we close below the 5MA, then we are out.
There is another method, created by the Chuck Le Beau, that has proven to be very succesful, even if a little bit more complicated: the chandelier exit. This method trails the stop based on previous high points. It can be the highest high of the trade, or the highest close of the trade. This is in fact the strategy that Van Tharp used to demonstrate that a strategy with random entries could be profitable with a valid exit strategy.
The stop is determined by substracting a value X from the high. X could be in dollars, in points, or, my favorite, a multiple of the ATR (Average True Range). So the stop could be:
– Highest high of the trade minus $1,000
– Highest high of the trade minus 5 points
– Highest high of the trade minus three Average True Ranges.
As we print higher highs, the stop moves higher instantly. By using Average True Ranges, we avoid being being stopped-out by "noise".
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