Exit With Profits, Not Regrets

Last Thursday, I discussed the need for aggressive exit strategies in trading the current market. Today we'll examine several ways these tactics are put into action and how they can benefit your bottom line. Although these examples focus on protecting profits, they're just as valuable when considering stop placement.

These strategies have one thing in common: They require closing out your position without hesitation at a predetermined reward target. This means you'll exit the trade as soon as price hits the trigger point, regardless of how good or bad it feels at the time.

As you gain experience applying these tactics, you discover that short-term trends appear drawn to specific hotspots before they change direction. This underlying structure lets you visualize your actions well in advance so you can ignore the thrill of the moment and take profits without hesitation when the time comes.

But how do you protect profits if price never reaches the reward target? The best method is to fall back on a profit-protection strategy such as a trailing stop-loss. In other words, keep a fail-safe exit behind advancing price just in case the market turns ahead of schedule.

Then use it to abort the trade and even consider a "stop and reverse," in which you take a fresh position in the opposite direction.

Old Gaps

Stocks love to fill old gaps, and they'll sometimes wait months or years to do so, as the above chart of American Power Conversion (APCC - commentary - Cramer's Take) shows. Look back on the chart for significant gaps that the current trend is approaching. Then exit the trade immediately when price hits the fill level. Afraid you'll miss part of the move? Run a trailing stop under the position as soon as it fills the gap. That way you'll get taken out on the first reversal.

Gaps are especially hard for opposing trends to overcome when they transit a wide-percentage range on heavy volume. Once stocks fill these broad gaps, they'll often reverse and start substantial movement in the opposite direction. So the fill point is an excellent place to take the money and run.

Capture the Flag

"1-2" setups such as those shown in the above chart of KLA-Tencor (KLAC - commentary - Cramer's Take) can really mess with our heads. We enter a long position when it breaks out of the bull flag and then notice the stock will complete a cup-and-handle pattern when it trades to $50. So we fail to catch the considerable profit from the rally off the flag in hopes of catching a larger-scale breakout.

A better strategy is to take profits blindly when the stock reaches large-scale resistance at $50. We can then watch for the breakout from the sidelines, treating the cup-and-handle as a separate trade that requires its own buying signal. The good news is that if the rally falls apart, we've already pocketed a big chunk of the move.

Measured Moves

The measured move lets you estimate how far the next leg of a rally or selloff should carry. The calculation begins by measuring the last trend before a simple correction, such as ChevronTexaco's (CVX - commentary - Cramer's Take) bull flag. In theory, the distance from the flag low to the breakout high should be equal in length to the rally that precedes it. This translates into a simple AB=CD formula.

You'll be amazed at how often prices move in measured waves. The trick is to watch it unfold and then have the courage to exit when price hits the target. Still not convinced? See if you can find other support or resistance that confirms your target. In this illustration, notice how the measured move corresponds exactly to whole-number resistance at $60.

Beware of Bar Expansion

Most times you can't predict price-bar expansion in advance, but it's a great exit signal when it comes. Let's say you were short Manor Care (HCR - commentary - Cramer's Take) last Friday when it sold off in a wide-range bar. I'll bet your first instinct was to pat yourself on the back and think about the next big move down. But if I were short, I'd be using that bar to cover my position and take profits.

Why? Because big bars create short-term overbought and oversold conditions. They're often followed by days or weeks of contrary movement that retraces the price levels crossed in the bar. I'd rather have that money in my pocket than wait for the next leg of a selloff that may never come.

62: An Important Number

A little Fibonacci goes a long way in finding profitable exits. The above chart of Anadarko Petroleum (APC - commentary - Cramer's Take) provides an example. Corrections are often followed by bounces that reach 62% of the last selloff leg. This gives you a magic number to exit a long trade after buying a falling knife. Take the time to confirm your exit by looking for breakdowns from topping patterns and high-volume gaps. These will pinpoint where selling pressure will re-exert its influence.

Exiting trades using price retracements can be difficult psychologically. After all, these are telling you to get out when you're sitting on a profit in a rising market. But it isn't so hard to do once you realize that letting your profits run into a major resistance level is rarely a good idea.

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Alan Farley is a professional trader and author of The Master Swing Trader. Farley also runs a Web site called HardRightEdge.com, an online resource for trading education, technical analysis and short-term investment strategies. At the time of publication, Farley did not have any positions in any of the stocks mentioned in this article, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Farley appreciates your feedback and invites you to send it to [e-mail]. Also, click here to sign up for Farley's premium subscription product The Daily Swing Trade brought to you exclusively by TheStreet.com.

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