At the end of a movie, there are those who leave the theatre after the final scene and those who stay watching the closing credits for added value. A common concern among traders is knowing when to leave a trade and whether staying longer adds more to open profit. There are 2 indicators I like to place on a chart to help me decide on a suitable exit. Each providing its own signal for the end of a trade.
Average True Range – ATR
The main indicator I use for preserving open profit is the Average True Range (ATR). It is an indicator of volatility, capturing the average range of movement for a particular stock. A price movement beyond the ATR line means an out of average range price movement.
For example, an ATR of 2 means a calculated value of 2 times the average price movement of a stock. In a long trade, a close below the ATR line means price has moved beyond 2 times the average range of movement. It signals a change in trend and trades are usually closed the next day.
In addition to the ATR, I like to use another volatility indicator, the Count Back Line (CBL), particularly when trading daily charts. Traders who wish to monitor an open profit more closely may find the CBL useful as it often follows current price more closely than the ATR line.
Count Back Line – CBL
The CBL is a calculation created by Daryl Guppy. It provides a short-term support level for the market as price moves higher and is recalculated each time a stock makes a new high. As the recalculated support level moves up with price, the CBL becomes a trailing stop loss and profits are protected.
It is easily calculated manually if your software does not have the CBL indicator.
The Count Back Line in an uptrend is calculated by identifying the most recent high of the trend, Figure 1, in this case the candle marked here by 1. From the bottom of candle 1, a horizontal line is drawn to the left until it hits the next candle with a lower low, candle 2. From the bottom of candle 2, a line is drawn horizontally to the left until it hits the next candle with a lower low, candle 3. On the third candle a horizontal line is drawn and projected to the right. This line becomes the CBL value as well as a short-term support level. A price fall and a close below this support level provides a signal to exit the trade. When price closes below the CBL the uptrend is no longer intact.
Using the CBL indicator to lock in a profit is like exiting a movie after the final scene. It’s the first signal indicating an end. Using the ATR line is like staying for the credits in a movie, spending more time in case there was something more such as a bonus scene or two at the end. In the case of a short-term trade, staying longer for potentially more profit.
The following past trade on INR, Figure 2, shows how both the ATR and the CBL are used in a short-term trade on the daily chart.
An analysis of the more recent activity on the daily chart of INR, Figure 2, shows widely separated lines in both the short-term GMMA and the long-term GMMA indicating strong support from both traders and investors.
The second last candle clearly shows price pulled back to the lower edge of the short-term GMMA before being rejected then continuing up the next day. Taking into consideration the bigger picture of the uptrend on the Weekly chart, (not shown), price had a high probability of continuing upwards. An entry was made as marked by the blue arrow.
Using the daily chart for managing the INR trade, Figure 3, a position was opened at an entry price of $0.33, a 15% target profit of $0.38 and a 2*ATR stop loss of $0.28. The next day after entry, price made another retracement down towards the top edge of the long-term GMMA. Price bounced off the long-term GMMA and continued to close higher each day, reaching an intraday high of $0.49. The ATR line was used as a trailing stop loss to protect the open profit. After the high of $0.49, price started to travel downwards together with compression of the short-term GMMA. A gap down occurred with price closing below the ATR stop loss line. This was the exit signal to close the trade.
On the chart in Figure 3, I have drawn the CBL using the most recent high of $0.49. Starting with the candle at the most recent high of $0.49 as number 1, we count back 3 candles with significant lows as described earlier. A line is drawn across to the right from the low of the third candle marking out the current CBL price of $0.42.
For some trades, if I want to monitor price falls more carefully to preserve profit, I often use the stop loss indicator closest to price. A trade is closed when price triggers either the CBL first or the ATR line first and is dependent on the strength of the trend. On the chart of INR, Figure 2, the CBL was higher than the ATR line. The CBL line was triggered at the same time as the ATR line with price gapping down and closing below both lines by the end of the day. The short-term GMMA lines had earlier compressed and began to fall towards the long-term GMMA. This was an early warning signal of a weakness in the uptrend. An exit is usually executed the next day after a trigger of the preferred indicator. My position was closed at an exit price of 0.42. A profit of 27%.
Double confirmation from these 2 indicators together with the collapse of the short-term GMMA down through the long-term GMMA, signalled the end of the uptrend. After the position was closed, price continued to fall to $0.34.
Whether you use the CBL or the ATR to exit a trade is a matter of strategy. Each indicator generates its own end of trend and trade signal. By choosing to close your position, it is similar to when a movie ends, it ends with your decision.