With downward pressure on shares continuing, the best thing a short-term trader can do is to look for a good exit strategy for their short-term positions.
Just as in long-term trading, where market turns are accompanied by sentiment extremes, taking short-term profits on your shorts is best when short-term sentiment is bearish.
And you can get a feel for this just by reading the financial mainstream media. Recently, comments have turned against commodities – with gold at the forefront – and since the FTSE index is filled with commodity producers, naturally, sentiment has turned sour on it.
And the FTSE has offered a great example in how to spot clues which can provide good exit points.
When to take short-term profits
On Friday, I showed the hourly FTSE chart of the big wave 3 decline, which was in full flow then:
Naturally, this wave 3 will not go on forever, and if a short entry was made near the wave 2 high, substantial gains are being accumulated, which a short-term trader should not let get away!
The question is this: How can I tell when the wave 3 has turned into a wave 4 up?
Let’s take a look at the hourly chart since then (below).
The market hit the round-number 6,300 level last Thursday, then rallied to my upper tramline and yesterday, fell back to the 6,300 level.
But in so doing, it created a positive-momentum divergence (red bar). To me, this was a good enough clue to take a short-term profit of around 400 pips.
And as I write this morning, the market is rallying up to my upper tramline once more.
The odds are growing that we are in the early stages of a wave 4 up with the wave 3 low in place.
As the whole world and his dog knows, stock markets are heavily influenced by what investors/traders believe the Fed’s actions will be.
To taper or not to taper – that is the question.
Up to the 22 May stock market highs, opinion was certain the Fed would continue with its quantitative easing (QE) stimulus for the foreseeable future, since the macro economic data was on the weak side. This produced the absurd situation that bad news was actually good. But we have seen a big correction off the 22 May high as opinion leaned towards the Fed actually reducing its QE programme in the near future.
But now that sentiment has turned negative towards stocks, it is highly likely that opinion will switch back yet again!
That means stocks will possibly rally above my tramline into the resistance area of the pink zone.
So the trader has a dilemma. Do you exit all your positions at once – say near the 6,300 level?
The problem is that the market may decide to move below this level and go on to make new lows, and you would be missing out on extra profit – and possibly kicking yourself into the bargain.
My split bet strategy
In my trading workshops, I teach a simple strategy that I call the split bet strategy.
Let’s say I entered a short trade at the 6,700 level and bet two pips a point (or a multiple).
One of the pips I will trade short-term and the other I will trade longer-term.
I have taken a profit at the 6,300 level – but only on the first pip. This gives me a banked profit of 400 pips.
But I still have the other pip working! That is when I can move my protective stop to break-even. I will let the market decide what happens to this trade.
The worst case scenario is that I make 400 pips on the first trade and nothing on the second.
The best case is that I make 400 on the first and more than 400 on the second.
This is a good situation to be in and avoids the frustration of seeing the market sail on without you being on board.
Of course, there are many variations on this theme – and I encourage all of you to explore the best options for yourselves.