Trading Rule Changes

Leverage is a wonderful thing for a trader. Except when it isn't.

When leveraged trades go well, it's sheer joy to watch the unrealized profits roll in. But a reversal, even a small one in percentage terms, can wipe away those profits in a day and turn the position into a loss.

I've experienced a good bit of that lately. So, in response, I'm doing what any good private trader does: Try to fix the problem by changing the trading rules.

The problem clearly lies in the exits. Nearly all the position I enter show an initial profitable trend. But under my rules, I tend to overstay my welcome, and that's when the losses happen. The answer, then, is to tighten the exits while still allowing room for fluctuation.

I don't want to thrown out the baby with the bath water. I'm aiming for the minimum necessary change.

In my exit rules, set forth in "How I Trade", I distinguish between a phase change and on oscillator.

Truth is, under the current rules, no position hits phase change while I'm still in it. I've been closed out by an oscillator long before the phase change happens.

So clearly, the current exit rules aren't very useful.

The changes:

I take two of the oscillators and make the phase changes. That means once they're triggered, there's no re-opening the position until the price again moves beyond the boundaries of the 55-day price channel. Two oscillators remain, with easier re-entry.

The centerpiece of this revision is the Two-Day Rule. Up to now, this rule has said that under certain price patterns, a position is closed if the price trades within the price channel for two days immediately after breakout day.

I'm expanding the two-day rule into an ongoing requirement. If the price closes within the price channel for two consecutive days, the channel must be closed, and a new breakout is required for re-entry. In practical trading, "closes" means that if the price is within the channel on the second day during the last half hour of trading, then I'll close the position rather than wait for the next day.

This change will have three effects.

1) There will be more whipsaws. No problem. It's cheaper to pay the commission than to absorb the losses.

2) There will be more breakouts that can be included on my daily Top Prospects report. This is not a good thing, necessarily, because my goal in technical analysis is to reduce trading opportunities to the best of the best. But this can be mitigated somewhat my tightening liquidity and fundamental analysis requirements for entry.

3) The phases in my daily Indicators report will reflect the new trading rules, making phase changes more likely to occur.

Here are the new rules for bull and bear positions.

On a daily chart with 55-day and 20-day price channels and the ADX...

Bull Entry

• Has the price traded above the 55-day upper line (the breakout level on the breakout day)?
• If yes, then is the ADX at 25 or greater
• If yes, then is the ADX higher than on the previous day?
• If yes, then is the parabolic sar in bull phase?
• If yes, then open a bull position at a price above the breakout level.

Bull Exits

Phase Change 1: 20-day channel
• Has the price traded below the 20-day lower line?
• If yes, then exit the position.
• Consider the phase as neutral and re-enter only on a new price-channel phase change.

Phase change 2: Two-day rule
• Has the price closed within the price channel for two consecutive days?
  If yes, then exit the position.
• Re-enter the position when the price again rises above the price channel while meeting the ADX and PSAR requirements for entry.

Phase Change 3: Stop/loss:
• Has the price traded below a) the low on the breakout day less the ATR, b) the breakout level less the ATR, or c) the highest high since the position was opened less double the ATR (whichever is highest)?
• If yes, then exit the position.
• Re-enter when the price crosses above the price channel while meeting the ADX and PSAR requirements for entry.

Oscillator 1 (ADX reversal):
• Is the ADX 40 or above?
• If yes, is the ADX less than on the prior day?
• If yes, then exit the position.
• Re-enter when the ADX again turns up with a rising price trend while meeting the ADX and PSAR requirements for entry.

Oscillator 2 (parabolic sar divergence):
• Has the parabolic sar moved above the price (turned bearish)?
• If yes, then exit the position.
• Re-enter when the parabolic sar moves below the price (turns bullish) with a rising price trend while meeting the ADX requirements for entry..

Bear Entry

• Has the price traded below the 55-day lower line (the breakout level on the breakout day)?
• If yes, then is the ADX at 25 or greater
• If yes, then is the ADX higher than on the previous day?
• If yes, then is the parabolic sar in bear phase?
• If yes, then is the intra-day direction congruent with the breakout direction?
• If yes, then open a bear position at a price below the breakout level.

Bear Exits

Phase Change 1: 20-day channel
• Has the price traded below the 20-day lower line?
• If yes, then exit the position.
• Consider the phase as neutral and re-enter only on a new price-channel phase change.

Phase Change 2: Two-day rule
• Has the price closed within the price channel for two consecutive days?
  If yes, then exit the position.
• Re-enter the position when the price again falls below the price channel while meeting the ADX and PSAR requirements for entry.

Phase Change 3: Stop/loss
• Has the price traded above a) the high on the breakout day plus the ATR, b) the breakout level plus the ATR, or c) the lowest low since the position was opened plus double the ATR (whichever is lowest)?
• If yes, then exit the position.
• Re-enter when the price crosses below the price channel while meeting the ADX and PSAR requirements for entry.

Oscillator 1 (ADX reversal):
• Is the ADX 40 or above?
• If yes, is the ADX less than on the prior day?
• If yes, then exit the position.
• Re-enter when the ADX again turns up with a rising price trend while meeting the ADX and PSAR requirements for entry..

Oscillator 2 (parabolic sar divergence):
• Has the parabolic sar moved below the price (turned bullish)?
• If yes, then exit the position.
• Re-enter when the parabolic sar moves above the price (turns bearish) with a rising price trend while meeting the ADX and PSAR requirements for entry.