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86

Gauging the Profit Potential

Knowing wiien to take profits in a valid reversal is probably one of the most difficult decisions to make. Although the decision is very subjective, selling rules can improve your executions. Your ability to take profits will determine your success or failure. Therefore, it is important to create rules to help cut losses to a minimum, while letting the profits ride.

Consistency

In my opinion, the most important concept of trading is to be consistently profitable. This is not an easy task. It requires that you identify profitable opportunities correctly, execute the trade effectively and take profits accordingly. Consistent profitability can be achieved through defining your actions in advance. Creating a plan to take profits will help increase profit consistency.



Some of my best trades have been when I have taken very paltry profits. When a stock does not act the way it "should," I get very apprehensive. Of course, I want the trade to work out for me. However, this struggle, of wanting to have the market move in my direction versus the reality ofwhat is happening, can be very difficult to overcome. It takes some time before you can differentiate between these two realities.

Mark Douglas, author of The Disciplined Trader and Trading in the Zone, is an expert in this area. I strongly urge you to read both of these books. He clearly explains the psychology needed to be successful. He stresses the need for trading rules, as the means to be consistently successful in the market.

I was not consistently successful until I developed my own trading rules. Although I have included my own trading plan, I strongly encourage you to design your own rules. But, this means that you have to follow the rules! This can be difficult, since dangerous emotions of greed and fear can influence trading behavior.

Exit Rules

I maintain several rules when I am preparing to exit a trade. I calculate the "spread of Fibonacci numbers" that could act as a future reversal point. The spread of numbers consists of both primary and secondary numbers. They are: 0.382, 0.50, 0.618, 0.786, 1.00, 1.27 and 1,618, For example, if I bought a stock on a daily set-up, I will calculate the spread from the previous high to the recent low. I will then examine the stock as it rallies through these points. If a stock experiences resistance at a Fibonacci number, I will usually take my profits and look for another set-up. However, this is dependent upon the price action out of the potential reversal zone.

Continuation Strategies

After I execute a trade, I use a very simple technique to determine the extent that I stay in my position. It is based on analyzing the price actions continuation after a reversal.

As the following illustration demonstrates, price action that continues in a clear direction will keep me in a trade. Using the buy example, if a stock rallies off a potential reversal zone and continues to make higher highs



and higher lows, I will stay in the trade. Although this may seem rather simplistic, many harmonic set-ups yield very strong reversals with overwhelming continuations.

Bullish Continuation

Bearish Continuation

As a stock rallies, I scrutinize the areas where critical Fibonacci numbers exist. If a stock begins to reverse off a Fibonacci number, I will take profits. Sometimes, I will sell half of my position and let the other half ride, in case the stock continues its rally.

Another important consideration in taking profits is to examine the previous price bars. In the buy example, if I am using a daily chart, I want to closely watch the previous days high, low, open and close. Ideally, I want all four components to be higher than the previous day. However, the ideal situation does not always occur. Therefore, it is important to assess these components, as means of determining areas to take profits.

I believe the high and the low are very important in indicating the future trend of a stock. In the buy example, if a stock can make new highs, I regard this price action as very significant. Also, a stock can stay above the previous days low would suggest strong price action.

The high and low are important, when they are combined with the open and close. As I have previously discussed, bullish and bearish price



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