My Double Support Trailing Stop Technique
Like most traders, I have a whole checklist of criteria
that must be met before I will consider purchasing a stock. I spend a
substantial amount of time researching potential candidates so that I may find a
few stocks that meet my criteria. One of the most frustrating and difficult
things for me is finding a great stock, buying it at the right time, and then
being stopped out of it just before it reverses and goes on to huge gains.Â
Having traded in multiple time frames over the years, I have experienced this
frustration with day, swing, and intermediate-term trades.
To keep myself in winning trades longer and avoid being shaken out early, I
developed my “Double Support Trailing Stop Technique.â€Â I will show an example
of this technique on an intermediate-term trade, but have successfully employed
it in many different time frames, and originally created it for my daytrades.
The Concept
The idea is simple. If I
require a large number of reasons to enter a trade, I should require more than
just one reason to exit it, if I want to catch as much of the move as possible.
I will therefore require two levels of support to be broken before I will
PERMANENTLY and COMPLETELY exit a trade. How you
define support does not really matter. You can use pullbacks, consolidation lows
(or highs), Fibonaccis, moving averages, trend lines, or whatever fits your
trading style.
An Example
Being that the below
example is an intermediate-term trade, I simply used consolidations and
pullbacks, along with the 50-day moving average (shown as the rising blue line)
for my support levels. I define a pullback to be any bar (or series of bars)
with a lower low AND lower high after a stock has
made new highs. The stock shown is Headwaters
Â
(
HDWR |
Quote |
Chart |
News |
PowerRating).
I purchased this stock as it burst out of a flat base in the middle of March. My
initial stop on the breakout would have been 8% from my purchase price, or the
low of the base. After breaking out, it moved up sharply for 5 days before
starting to pull back. It pulled back for seven days before reversing and moving
higher. The low of this pullback is near the first green arrow labeled
“Supportâ€. It became support in my eyes after the stock move higher from there
by making a higher high and higher low on the next bar. When that happened, I
was able to move my initial stop up to the breakout point. (I consider the high
of a flat base or high tight flag to be a level of support also.)
Next, the stock
moved up again for several days before making a second pullback down to the
green arrow labeled “Broken Supportâ€. The “Broken Support†bar was initially
just the next area of support after the stock had pulled back and moved higher.Â
When that happened, I was able to move my stop up under the first green support
arrow. It became “broken†5 days later when the next bar labeled “Supportâ€
moved below the low of “Broken Supportâ€. If I had exited at the “broken
support†level here, I would have been shaken out of the stock and missed the
rest of the move. Instead, the stock continued to move up and create higher and
higher support levels.
The time came for me
to sell this stock at the area marked “Double Support (Sold When Broken)â€. It
was at this time that the stock moved below two levels of support. The first
was the 50 Day Moving Average, and the second was the pullback low just above
the “Double Support†green arrow. As you can see, this turned out to be a good
time to take profits and exit this trade. Three days later, it was trading
nearly 30% lower.
Additional Considerations
Earlier, I used the
term “permanently and completely exit.â€Â Due to the fact that the first and
second levels of support may be very far away from each other in some instances,
I may consider exiting the position partially, or exiting and then looking for
an opportunity to re-enter the position, when it breaks the first level of
support. The main reason I would do this is not to give back too much of my
profits. Once two levels of support are broken, I want to be completely out of
the position and will not consider re-entering without a whole new base setting
up.
Since the “Double
Support Trailing Stop†will keep you in positions longer, it is most effective
for intermediate term trades when you are trading with the overall trend of the
market. In other words, long positions in an uptrending market, and short
positions in a downtrending market. If you are using it to manage day or swing
trade positions using 5- or 15-minute bars, then the overall market trend does
not matter as much.
Rob Hanna manages a hedge fund in Massachusetts. He has traded for
several years, focusing on multiple time frames and has been a TradingMarkets
member since the site’s inception. Should you have any questions on this
technique, you may email him at
robhanna@rcn.com