Exits Need to be Simple

There is something that goes on inside everyone's head when they sell a stock. That something is usually a combination of concern, doubt, greed, pleasure, and fear. When you buy a stock its mostly an excited reaction, much like placing a bet in a casino. Your heart may start to thump a bit and you will gladly watch the movement of your bet up and down. But when you sell, it doesn't matter if you are a winner on the trade or not. You will still wonder what if it keeps going up? What if I am selling at the bottom and its about ready to rally back? What if my indicators are not sending me a clear message?

This gets at the very heart of what I mean when I say your exits need to be SIMPLE. The less indicators you have the better, the less wiggle room you have to keep the trade on the better. Indicators can always be interpreted differently depending on your current bias. This is why I am instituting a "no indicators for exits" rule with my trades going forward. It is frankly to easy to convince yourself of not taking action when you use indicators for exiting trades. The only thing you should use for exiting trades is price.

If you have conflicting signals from price and your indicators, you will end up siding with your emotions and choosing to follow which ever sign fits your narrative best. If you want to be successful managing your own and other people's money you have to be able to remove the emotional element to trades and operate from a clear frame of mind.  Price is as clear as anything can get in an uncertain market environment. Its either in an uptrend, downtrend, or sideways trend. You then find the point where the current trend becomes invalidated and that is where you place your stop. If price closes below that level, the trend has changed and its time to step aside. Simple and no room for emotional interpretation.


The position that is stirring these thoughts in me is CMI with today's earnings gap down to begin the week of trading. I'll do my best to take you through my thought process here and why I am making this slight, but important change to my exit plan.

As you know by now the primary indicators I use to watch stocks are the Relative Strength ratio trend, 20 week moving average, Bollinger Bands, and occasionally when I wish to confuse myself more I will glance at the weekly MACD reading. The problem becomes when I am determining where I will exit the trade, I will wish to see all these indicators line up for a confirming signal. The problem is most signals trigger at slightly different times than others. That will confuse you on when is the right time to exit the stock.

Looking at CMI above (granted its mid-week, so this weekly bar has a lot of work still to do) you can see that slice through the 20 WMA and the gap lower that appears to break my RS trend support just as it did in late January. Based on this current view the stock looks like a clear sell at the close of the week. But then I saw that I could draw the same chart like this and tell a different story:

 From this angle if you incorporate the little RS break in January with the "revised" trend support, the ratio is simply pulling back to the line. When looking at price, instead of the toppy action in the first chart, this looks like just random movement within the uptrend channel with support at $140. Plus you can see over the past few years that each time the 20 WMA was broken it was broken violently and ended up reversing shortly after. So using the 20 WMA as a confirmation here is not a very accurate representation of the price movement and trend.

Seeing what a mess the conflicting indications around price suggest, we need to find a way to simplify the decision while still being fair to the dominant action in the stock. So what we need to do is step back, clean this chart up and focus on the only thing that matters, price.

Looking at the last 10 years of weekly bars you can clearly see a strong trending stock. The only thing to worry about in this view is that it has gone up too much...Whats the most bullish thing a stock can do? Oh yeah, continue to make new highs. Guess you have to chalk this one up to the bulls.

Zooming in on the last 5 years there was an orderly and substantial uptrend from 2009-2011. Price then traded in a sideways range for the better part of 3 years. We are once again moving away from the digestion area and seem to be resuming the prior trend. I would say another win for the bulls.

Now looking at our current situation price is in a strong established uptrend channel, with a very defined breakout-retest support area just near the channel support.

 What is interesting here is that once you remove the bias causing indicators, the derivatives of price, you are left with the true representation of supply and demand. And thats what this all comes back to, where are the buys and sellers in this market? If you are following price and trend its hard to argue with this clean of setup and channel. I think the prudent exit strategy here is to find the area where you know your trend is invalidated. That point to me would be below the support zone AND coincide with a failure of the 2-year uptrend channel. Call it $139 for now.

Due to the strong nature of this uptrend I believe I was getting a bit ahead of myself with my trailing stops. I was letting the indicators extend me from the actual levels of support and resistance, from trend invalidation. I was being led away from the bigger picture in this stock and was continuing to focus too much attention on the short term.

So here is the updated exit strategy with CMI:

 I still value my indicators, but when it comes down to pulling that sell trigger you simply have to put them aside and focus on what single element ultimately determines your fate in the trade. That simple factor is price; if price goes up I make money, if it goes down I lose money.

I feel strongly that indicators have an important place for trade entry as a confluence of indicators can confirm a price move, suggesting a very high probability of success. If you get conflicting signals, you can simply pass on that trade and look for a cleaner setup. But when you are already in a trade you cannot be dismissing a signal here or there and just decide that since they all don't agree that we will just continue to ride the sinking ship until they align. You could lose a lot of money that way and you simply don't have the luxury of non-action when you are in a live position.

Keeping it as simple as possible for position exits is very important to our success as investors. Avoid emotions, see the stop clearly, and execute once the trend is invalidated. Often we need to remind ourselves of these things as the markets are constantly evolving and changing, we need to remain nimble as well.