Knowing the Ins and Outs of Chandelier Exit
Have you ever heard of a stop placement strategy that trails stop based on previous 'high' points? It is called Chandelier exit as it hangs down from the high point or the ceiling of our trade, just as a chandelier hangs from a room ceiling. The distance, which is usually calculated from the high point to the trailing stop; could also be calculated in dollars or in contract based points. However, the value of this trailing stop moves upward very promptly as higher highs is reached.
The Chandelier Exit, which has a trailing stop from either the highest high of the trade or the highest close of the trade, is best measured in units of Average True Range (ATR). One of the many factors leading to use ATR for measuring the distance from the high to our stop is that, it is pertinent across markets and is adaptive to changes in unpredictability.
The essence of this calculative measure is that, even on expansion and contraction of trading ranges, our stop will automatically adjust and move to the apt level, thereby, constantly staying in tune with changing market conditions. Chandelier Exit is one of the most tried exit methodology used across a varied portfolio of futures markets to generate profitable test results.
It is imperative that the changes in unpredictability can curtail or stretch the distance to the actual stop, since the highs used to hang the Chandelier move only upward. However, in order to witness less fluctuation in the stop distance, you can use a longer moving average to calculate Average True Range. In other ways, shorter moving average is required, in case you want the stop placement to be more adaptive to fluctuating market conditions.
When short averages for the ATR is used; brief periods of small ranges can bring the stops too close, abnormally resulting in premature exit. To avoid this, you can have a short and highly adaptive ATR while calculating a short average and a longer average and using the average that produces the widest stop.
Although Chandelier Exit differs from Channel Exit (which trails a stop based on previous 'low' points), the combination of both, where the trade is initialized by the trailing Channel Exit and then adding the Chandelier Exit, after the price has moved away from the entrance point, will help in making the open trade lucrative. Here the Channel Exit is fastened at a low point and does not move up as new profits are accomplished. At the same time, it is necessary to have the Chandelier Exit at the right position so that the exits are never too far away from the high point of the trade.
The fundamentals behind combining the exit techniques, Channel and Chandelier exit is that, while Channel Exit as a suitable stop that very steadily rises at the commencement of the trade, switching over to Chandelier Exit is necessary to ensure better exit that protects more of our profit. This feature makes Chandelier Exit one of the most sought after rational exits from the profitable trades.
How Does the Relative Strength Indicator Function?
Have you read Welles Wilder’s “New Strategies in Technical Trading Systems?” If you haven’t I would advise reading the book today. If you want to trade the RSI, learn about it from the original text, and apply the original RSI knowledge to your trading. Don’t settle for the endless stream of reviews and technical explanations on the nature of this remarkable volume, and don’t be satisfied with simply understanding a bit about his technical indicators. No, I think a proper foundation in trading starts at the source, not the endless stream of late comers who have adapted aspects of the book into their trading systems. Now let’s get started with the RSI.
Let me ask you a quick question. What do all of the following have in common?
1. Relative Strength Indicator 2. Directional Movement Indicator 3. Average Directional Index 4. Parabolic Stop and Reverse 5. Average True Range 6. Wilder Smoothing Average
The were all in one book! Yep, “New Strategies in Technical Trading Systems” is the source. Of course, today we are going to concentrate on just one of those indicators, the Relative Strength Index, or RSI.
RS = Average of x days’ up closes / Average of x days’ down closes
The RSI is an indicator that compares recent gains and recent losses to formulate a system for determining overbought and oversold conditions. I can’t see it as a stand-alone indicator, as it tends to whipshaw you in and out of the markets, but it is the perfect indicator to use in conjunction with other indicators. I use it as a confirming indicator for my primary indicator.
There are three primary areas to pay attention to when trading the RSI. The overbought area is derived from the data when the indicator hits 70. The oversold indication is derived from data when the indicator hits 30. In his original thesis, both these readings (70, 30) were buy and sell points of the RSI. Since the RSI is used to measure the strength of the underlying security, there is a wealth of information to be gleaned from the RSI. Again, I caution you in trading the RSI as a primary indicator.
Another system uses the RSI in a similar manner, except it focuses on the 50 line in the RSI. Some believe that when the RSI pierces the 50 line going upward a buy signal is generated, and the corollary is true also…when the line is headed downward through the 50 line, a short signal is generated. While I am aware of these two trading methods, it’s not what I am looking for in the RSI, though the information is valuable for confirming trade decisions.
No, I want to look a price divergences with the RSI. When the RSI is headed one way and the price action on the chart is headed another I like to take notice, especially if I am currently in a trade. Divergent indicators are the stuff of gold, and they are hard to come across, especially in short term trading, but the RSI shines at it’s assigned task. When price is still headed in an upward direction and the RSI joins that movement direction, I am looking for a point in time when the RSI changes direction, and it usually begins to swing before the price movement reflects the deteriorating underlying short term trend. Put in less esoteric terms; if the price is going up and the RSI starts to head down, you better be prepared to take quick action. Convergence and divergence are what makes guys like me, who trade with price action and oscilllators, feel good. Any information that I can glean about what is happening in the market is helpful, especially when you are trying to scan your screen for something that isn’t necessarily reflected in the charts.
I feel using the RSI makes me a more nimble trader, more informed. It generally occupies the middle of the indicator row, second from the top. Once I am in a trade I generally keep a close watch on what the RSI is trying to tell me, and then plan my strategy accordingly. My recommendation is to give the RSI a try, and see if makes sense in your overall trading strategy. Are you paying attention to divergent indicators? You should be.
More on Emotional Considerations in Your Day Trading
You have a responsibility to be prepared mentally each day you choose to day trade. Many traders shun the emotional realities of trading, and this aspect of trading is among the most important. Recent findings in scientific studies reveal, unequivocally, that a traders emotional state during a trading session may be the single most important factor in determining whether a trader has a successful day or loses money.
In my experience the best way to quiet a group of chatting traders is to ask them about their emotional preparation to trading. For a variety of reasons, traders are reluctant to discuss how they feel, at the emotional level, during their trading. Whether the root cause of the this phenomena is vanity, inability or reluctance to share emotional tendencies, or a societal norm for traders to be mentally “tough” is unclear. What is clear, however, is the incontrovertible evidence that states that your mental and emotional state has a profound effect on your ability to trade.
In a past article I discussed outside factors like television, radio, and music that effect our emotional state, and in this article I will discuss internal emotional considerations each trader must conquer. There is a feeling that some traders are gifted, that they are natural born traders. It is my opinion that some traders have an emotional profile that makes them successful, as oppose to a technical style. As a chaos theory trader, I am convinced the market is, at the macro level, random and difficult to predict. At the micro level, certain patterns occur over and over. That being said, most of the successful trading systems share some common characteristics and very little has occurred in the past ten years that we could consider revolutionary breakthroughs in trading technique. To be sure, no trading style has in any way pulled ahead of the pack of mainstream traders. Sure, we have new styles of trading, but the ultimate judge of trading successfully is profits and losses, and the new styles have done anything but disproved the long standing tenets of trading with their profits and losses.
So what kind of emotional situations hinder a trader?
Emotional attachments to a trading position are among the toughest to recognize and rectify. For a variety of reasons, traders invest their emotions into a particular trade in the belief they are right, despite overwhelming evidence to the contrary. For example, a trader may decide the market is going to go in a certain direction for a certain period of time and positions his trade to capitalize on this perceived winning trade. Before long, the market begins to move counter to the trader’s theory, but the emotionally invested trader does not take corrective action because he is convinced he is right. Despite his indicators telling him he wrong, despite the market price action that is telling him he is wrong, the trader has invested himself so deeply in his conviction he is right he rides a trade straight into his stops. (if he has stops) When I think I know what the market is going to do, especially if it is contrary to what my chart is telling me, I know it is time to stop for the day.
What causes this phenomena?
The need to be right, basically. The literature on this topic suggests there are more than one factor that contributes to emotional attachment to a given trade. Losing trades are a part of day trading, and how you handle a trade at the emotional level will determine whether or not you can trade successfully. You are not going to always be right, and an individuals ability to accept that he/she was wrong and move on to a new trade is essential. It sounds very easy, but it’s not. Many traders are unable to adjust if they are in a losing trade, it unnerves and rattles them. I have watched many traders battle this problem and most are unable to conquer emotional investment in a trading position. For some, their need to be right simply overwhelms the intellect they possess. While emotional investment in trading positions is not necessarily the end of a traders career, it takes a considerable amount of work to overcome.
Another serious emotional issue with traders is overconfidence, especially on a day with many winning trades. This is a tough issue to deal with. As you make good trades throughout the day, you become convinced that any trade you make will be a winner. It’s a great way to give back all you have earned, which is not uncommon. This usually occurs on a trending day when nearly all your trades will be profitable if you stay in the trend. Of course, the next day may well be a trend in the opposite direction, or a consolidating market, and your overconfidence becomes a distinct liability. You must be nimble in your trading, and not lock in on ideas to the point where you are not able to properly focus on the market. Overconfidence is terminal to a trading account. You must stay a student of the markets, not the master. There are few masters of the market, just observant and nimble traders.
In summary, we have looked at the effects emotions have upon trading futures. Many traders tend to become emotionally involved in the positions fail to adjust to the trading situation. They have an intense need to be right. Other traders become confident, which is a great attribute to have if you are in a sporting contest with another opponent. On the other hand, the market is inanimate and overconfidence is poorly deployed in the trading environment. Your ability to recognize the emotional demands of trading will, more or less, be a major contributor to your success.
