How to Exit Winning Trades - Part 2

07/18/2013 6:00 am EST

Focus: TRADING

Ken Calhoun

President, TradeMastery.com

It's smart to test out various exit signals to start scaling out of open winning swing trades at the first sign of trouble, says veteran trader Ken Calhoun of TradeMastery.com and DaytradingUniversity.com.

In the first article of this series, we identified the correct exit in the market at near the exact top (within one day of the multi-year high), designed to identify timing for exiting open long swing trades using the S&P chart. We also discussed the importance of scaling out of open winning trades in two steps, to close initial entries out over time, at key sequential support levels. Here, we'll look at closer technical exit signals for swing trades, with unique examples.

Scaling Out of Downtrending Swing Trades: A Tighter Two-Step Exit Plan
In the first article, we looked at both four- and eight-day support levels as exit signals. To extend that trading strategy, we now look at the special case where a swing trade is starting to exhibit signs of a downtrend, as defined by lower price action compared to a prior day. The goal is to start tightening in trailing stops to lock in gains at the first sign of a trend reversal.

In Figure 1, Calpine Corp. (CPN), we see that a downtrend has started to form midday (lower lows, lower highs for the current plus prior day's price action trend). To exit, we scale out of half the trade if price action gets .35 cents under the cumulative two-day low (current plus one prior day). For this CPN chart, that would be at (21.5 - .35) = 21.15 as the first scale-out exit. The secondary entry is to be set at a maximum of one full point under the cumulative two-day low, in this case (21.5 - 1.0) = 20.5 for the second, final exit.

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Traders often needlessly wait for extremely large drops before scaling out of open winning swing trades, with exits far too low, to lock in significant potential profits. It's a smart idea to test out various exit signals like those discussed, to start scaling out of open winning swing trades at the first sign of trouble, as illustrated in this chart, with a .35 below two-day low exit to start exiting the position.

A good breakout trader always thinks to themselves "I can start closing out a winning trade here since it's dropping, however I can always re-enter at new highs later, if it takes them out." This thinking can help traders gain a more focused edge in their trading, without sacrificing open unrealized profits in their positions as the primary objective.

NEXT PAGE: Swing Trading Exits

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Swing Trading Exits: Head-and-Shoulders Breakdown Exits
It's wise to become familiar with all bearish reversal patterns, such as head-and-shoulder patterns, and use these to help develop a two-step scaling out of open winning swing trading plan as well. In Figure 2, Zale Corp. (ZLC), there's an obvious head-and-shoulders pattern occurring on June 17 and 18, 2013, on this 15-day candlestick chart. While not a sign to exit immediately, a protective stop can be placed at (9.2 - .35) = 8.85 on an open swing trade, in case it does attract sellers, and the price action drops.

chart
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Similarly, a one-point trailing stop under the two-day low yields a final exit signal at (9.2 - 1) = 8.2 for any remaining open long shares in a swing trade. This two-step process (.35 under two-day low for exiting half a swing trade, and one point under two-day low for exiting the remaining half of a swing trade) is used whenever there's a bearish signal, like a downtrend or head-and-shoulders pattern.

Similar exits can be used with candlestick chart patterns such as shooting stars and bearish engulfing patterns at the first sign of weakness in the underlying price action of what's being traded. We'll look at candlestick chart patterns with two-exit trading strategies in a subsequent article.

Recognizing the Difference Between Trend Reversals vs. Minor Pullbacks
A favorite saying of experienced professional traders is "when in doubt, get out. When it comes to trying to decide about exits, and whether or not a trend has reversed, or is simply chopping around in a minor pullback, it's important to decide to exit sooner rather than later.

Solid uptrends are generally strong from the start and continue for a healthy distance. Anything less than the best strong trending charts is likely to cause trouble and not be worth trading. Using this two-day "in vs. out" process helps give traders a key decision-making process to use as part of their overall trade management plan. Buying new two-day highs, and selling two-day lows (meaning today plus one prior day, not two days prior to today), is a core professional trading strategy worth testing out.

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.

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