What to do when a market doesn’t quite reach a profit objective? It’s a routine problem for trend followers.
Under the Brent Oil strategy I posted on 22 October, a trader was greeted with a familiar situation on Saturday morning. The market got very close to the profit objective but hadn’t quite reached it by the close of trade. It was also a long way from the original stop. I’ve outlined some thoughts on how this might be handled for the benefit or readers following this trade.
The initial strategy was based on an ABC sell set up. This is outlined on the chart below. I haven’t repeated the details here. To read the original post on entry strategy click here and to read the follow up on setting the profit objective click here
Adding a filter to the profit target
Some traders might use the profit target to actually close the position while others will simply use it as a trigger to move the stop down and run the position further. Either way you need rules about when to do this.
It’s pretty common for markets to respect support levels by getting very close to them (a bit above or a bit below) while not necessarily hitting the level to the exact cent. This applies to Fibonacci ratios as much as it does to support lines and moving averages. So one approach is to use a price filter or buffer zone and set the profit limit a bit above the exact support.
Using a filter of about 0.5% on a daily oil chart would have seen a trader quit this oil position at around $105.80 this morning. However, you need to draw the line in the sand somewhere with this. If the buffer is too big, it will have a negative impact on trading results over time because it will take you out of too many trades earlier than necessary.
This leads to the 2nd part of most trend following exit strategies – the technique for moving stop losses. The aim here is to reduce the risk of giving up too much profit once the trend is underway but at the same time to give the trend plenty of room to run in your favour.
Moving the stop loss
One approach to stop losses is to move them down behind any new failure points in the trend being followed. In this strategy the original stop was set behind the peak at “c”. This was the original failure point. If price took this out then the original strategy of selling for a new downtrend beginning at “c” was clearly a failure.
Once the down trend got under way, a move back through or overlap past support at “1” would become a closer failure warning than the original stop. At that stage the stop could be moved down just behind “1” to $113.50. This changed the worst case result to a bit better than break even.
Now that price has left another low at “3”, overlap through that level represents a new failure warning. There is scope to move the stop down to that level. Of course this only applies if the strategy has not already closed the position for a profit.
Traders intending to run the position past the initial objective may give the position a bit of breathing room when price first gets below “3”. One approach to this is to use a 3 candle trailing stop. As soon as price gets under 3, the stop is moved behind the top of the 3rd most recent candle high. This morning the stop would have been moved to $110.30 using that technique
On the close of each candle that makes a new low, the stop is moved down behind the 3rd last high. This repeated until the third high clears “3”. The stop is then left behind the overlap point at “3” or at the first profit objective if price has completely cleared that level as well.