Exiting the Trade

Part IV - Using Technical Analysis

Whichever strategy you choose, your trading will improve by learning to use a few simple indicators in your trading. For the day trader, there are two primary things you should look at, if you want to start trading the charts. You can begin with these two things, and then add other indicators as you become more experienced. The two primary things are Price and RSI.

Price is reflected in the five-minute candle that is developing right in front of you on your chart. The five-minute candle constantly changes its appearance until that five minute period is complete. It can grow large and then fall back down. It can be both bullish and bearish, all within the same five minutes. But this candle is your most immediate window into the sentiment of the other traders involved in this trade. Their sentiment is directly expressed in this one candle. The color and the length of the body are critical. The appearance and length of the wicks and shadows add to your interpretation of sentiment. On top of this, each candle is justaposed to the candle that preceeded it. Are there higher highs and higher lows? Is the current candle engulfed by the previous candle? Has sentiment suddenly changed, with traders taking the profit from the previous candle quickly? Finally, you look at this candle in light of the rest of the market. Is the market going up, down, or sideways? Is your stock's candle reflecting the market, or is is oblivious to it and operating in its own world?

Price should be looked at in terms of its five relationships. You can view these relationships by asking these questions.

(a) How is price acting in the current five-minute candle? (b) Where is the current price relative to your entry price? (c) Does the current price activity reflect the strength or weakness of the wider market? (d) How does the current candle look relative to the previous candle? (e) Is price acting in sync or out of sync with the other indicators?

RSI is shorthand for Relative Strength Index. For day trading, I use multiple settings for my RSI. I use a very tight 2 and 4 setting on some of my charts, and a larger 5 setting on other charts. You might prefer a wider setting of 7 or 11. The main boundaries for RSI are the 20/30 and 80/70 lines that are usually set as defaults on your chart service. Over 80, and RSI is said to be overbought. Under 20 is said to be oversold. Some traders also use the Stochastics indicator for this determination But, if you will look at any chart, you'll see that the RSI changes frequently throughout the day on any stock. You'll also notice that there is a relationship between Price and RSI and that they tend to flow together, though the degree of their curves may not flow exactly in sync. The simple rule is that a rising RSI equals a rise in price and a falling RSI equals a fall in price. The degree of their movements are not always identical however. For example, price may move by only a few cents while RSI moves in a huge swing. In that case, you might watch price closely, to make sure it doesn't suddenly turn against you. But, if price doesn't fall dramatically, then RSI may soon turn up and suppport a higher price. So, you have to view Price and RSI together.

For the new trader, a focus upon the price candles and RSI is the beginning point for technical trading.

Below, I've provide a price guide sheet for combining these two indicators. These are meant as starting points. If you are new to technical trading, then they will give you something to hang your hat upon. But they are meant only as starting points. You can print this out and see how it works for you. As you advance, you will not need this sheet. You will begin to see what is happening as it develops. And you will develop your own internal trading compass, even though you may find it difficult to put into words.

You will see some of these combinations more often than others. Also, the physical appearance of each indicator is dependent upon the time frame in which it is viewed. Price and RSI tend to go hand in hand. But, when they disagree, this guide might help you take the appropriate action.

Summary

In this article, I have tried to provide a philosophical basis for trading and money mangement. We have looked at common exit strategies employed by traders. We have looked at different types of trades, and how those various strategies might be used in each of those situations. And we have looked at Price and RSI as two immediate indicators for assessing each trade's movements.

Developing an exit strategy that works for you will take time. But hopefully this paper has both challenged some of your assumptions and caused you to think about alternative strategies.

You can use these ideas to review your trades each day. Put your printed charts in one hand and your possible exit strategies in the other hand. Review each trade. Ask yourself the simple question: "What action could I have taken to better preserve my equity and maximize my profit?" Over time, you will discover a way of exiting the trade that accomplishes these objectives.

To be taken back to Part I of this series on Exiting the Trade, click here.