Let’s say that we’re set-and-forget trading – this is great because it means that we’re not tempted to meddle with our trades, jumping out early and snatching at profits. But when we do come to check on a trade that lost … we look at the chart and think: ‘If I’d seen that price behaviour, I’d have definitely jumped out sooner and saved myself some money’. Or with a winning trade, you might think: ‘The price was obviously powering up – I could have moved up my target and made double!’
On the flipside, there’s those of us who watch our trades, and spend much of the day with our fingers hovered over the ‘close’ button … ‘I don’t like that price action; shall I jump now?’ … ‘The price is consolidating; I’ll take profits here.’
Wouldn’t it be nice to save ourselves this torment?
We could use a simple exit indicator to give us a warning that all is not well with our set-up and now is the moment to jump rather than waiting for a stop or target to be hit?
We want advance warning – that means we’re looking for a leading rather than a lagging indicator. Something that’ll tell us what’s coming, rather than what’s already happened.
There are some solid options out there – Stochastics, MACD, Relative Vigor index …
I’m going with the MACD. I find it less sensitive than the other two, but depending on how you’re applying it and the timeframe you’re looking at, Stochastics and Relative Vigor can be applied in the same way.
The MACD is a momentum indicator based on moving averages. It appears below the price action on our charts, as two oscillating lines and a histogram, which measures the lines moving closer or further apart from each other.
A crossover of our MACD lines is our early warning signal to jump out of a trade. Here’s an example, where the blue arrows show buy and sell signals generated by my strategy on a 4-hourly chart …
If the MACD crosses over, against the trade direction (as marked with the orange arrows), we close out – whether it’s for a profit or a loss.
You may find the early warning signal given above a bit too slow. There are easy ways to speed this up …
You can switch down to a shorter timeframe. Here’s the MACD crossover at work on the same signals, but in an hourly chart …
Alternative, the Relative Vigor indicator is more sensitive, even on the longer 4-hourly chart …
Finding the right early warning system for your trading will take a little bit of testing – it’ll depend on how often you’re trading, what timeframe you’re using and what kind of stop distance you’re using.
The early warning system needs to kick in ahead of a stop level being hit – the point of it is that it gets us out before trades are stopped out. This can dramatically improve your risk-reward ratio on trades.
Leading indicators are, by their nature, prone to false signals – so, sometimes this early warning signal will get it wrong. As I trader, I hope you’re already very used to being wrong a fair bit of the time!
Secondly, we are deliberately looking for a sign that this move has run out of momentum.
Be aware, that jumping out of a trade because it’s stalling can leave you short of profits that it then went on to run to. All trends will have periods of consolidation. Waiting around in those periods adds to your risk. But prices often leave these ‘zones’ with a burst of momentum – something that trend traders can take advantage of.
Only by tracking results can you be confident that your early warning settings are saving you money rather than costing you.
For more information on exit indicators, please check out this post. And for tips on adjusting MACDs to suit the kind of filter you’re after, try here.
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