"You recommended taking profits on bullish positions this past weekend and there was strength to sell into before weakness today. How do you decide that its time to pull the plug? This versus riding a trend as long as prices are moving in your direction?"
Well, I'm not a 'trend follower' in the sense that you ride a trend when that trend is CLEARLY recognized by many. And then stay in your positions for as long as that trend lasts. Technically, this often involves using moving average crossovers and other types of indicators that represents a trigger point that suggests price momentum has reversed. This is a bit over-simplistic but it's the basis concept of staying in a trend as long as it lasts. Obviously this is a more intermediate to longer-term approach versus short-term, in and out, trading.
The foregoing philosophy is quite different from what I learned from my trading mentor (Mark Weinstein of Market Wizards fame) in attempting to find the START of new trend and taking positions accordingly, before a new trend is widely recognized. Risk-to-reward (and there IS risk) if your right on where a new trend begins, relative to trade potential can be quite favorable in this approach but it takes a definite contrarian streak.
Along with this approach, I tend to establish 'pre-set' objectives. As Mark used to say, if you get in "right" (early in the trend), typically in calls or puts, you can also get out 'early' so to speak; e.g., prior to the last part of a move, where volatility gets more extreme and there's more risk of giving back more of your (unrealized) gains. And more nail-biting!
The S&P 500 (SPX) daily chart here will demonstrate some of these points. The lows made at the lower end of SPX's long-standing uptrend price channel back in April occurred well under the 21-day moving average, but also when the Index was getting toward oversold RSI readings and when bearish sentiment (see CPRATIO indicator) was dominant.
The 3 successive SPX intraday lows at the lower trendline followed by a bullish upside 'breakaway' gap suggested that the long-term uptrend was resuming. Still, traders were cautious and that's when I define risk as being (relatively) low in getting into calls out 1-2 expirations. I was anticipating a 3-month or so advance given the dominant long-term bull market trend. Traders didn't get carried away with bullish enthusiasm until into June. For some time I've had an 1980-1985 objective for SPX. The recent line of highs highlighted at 1985 were telling for a top.
I wrote about one relatively simple, not the only, way to establish an upside objective for SPX in my 5/31/14
Trader's Corner which involves looking at the price gaps made by SPX.
So called (price) gaps on a daily chart are created when an Index or a Stock trades ABOVE the prior trading day's High, creating an UPSIDE price 'gap'; a downside price 'gap' is where a day's price range is BELOW the Low of the prior session.
Price gaps are created when there's space('gap') between one day's High-Low price range and the next. Gaps come about from news and events occurring outside of normal U.S. trading hours; e.g., news that is construed as bullish or bearish occurs from a report released after, or before, Market hours.
There's a rule of thumb with price gaps that says that a second gap in the direction of the trend after the trend has been underway for some time and, often, after an initial price gap in the direction of the prior, or a new, trend (a 'breakaway' price gap) will often be approximately HALF way in the ultimate move or in at least the next phase of the move. Using this simple rule-of-thumb, per the chart diagram, yields an SPX objective to 1986.
Of course, with a price objective close to the recent SPX peak which was FOLLOWED by the Index making a second top within a hair's breath of the first suggests yes, time to pull the trade trigger and exit SPX calls.
A similar 'measuring' technique applied to the same initial and second/later upside ('measuring') gap in the Nasdaq Composite (COMP) resulted in a possible COMP upside price target to 4462, versus the recent Index peak at 4485.
The Market often has 'rotational' corrections where some sectors are being sold and other groups are still being bought. We see this a lot in situations ranging from when the Dow is leading the overall Market; or, when Nasdaq is gaining much more than the S&P and Dow.
A definition of 'sectors' can extend to capitalization or SIZE, ranging from big cap 'mainstream' stocks in the Dow and the S&P 100 (OEX) versus large cap technology related stocks heavily represented in the Nasdaq 100. Sometimes small and medium cap indices like the Russell 2000 (RUT) are way outperforming the overall Market.
On this note, the OEX, Dow 30 (INDU) and NDX broke out to NEW highs recently, unlike the broader SPX and COMP indexes, which have seen a topping pattern. And we know that the small-cap RUT fell sharply from its recent top.
'Safety' is often perceived in big capitalized companies and while the S&P 500 and Nas Composite floundered, OEX and NDX rallied to new highs, so the 30 to 100 companies in INDU and NDX/OEX were still being bought.
I often talk about 'decisive' new highs with a fairly precise meaning for me. I use something loosely called the '2-day rule' as a key determinate for what makes for a decisive new high and a likely start of a new up leg. To confirm such a new up leg I like to see two consecutive days of back to back Closes above the prior Closing high. To date, neither OEX, seen below, or the Dow or the Nas 100, have managed to do that. All 3 indices (INDU, OEX and NDX) DID however do just as is highlighted below with OEX: pull back to their most recent up trendline; also holding above the noteworthy (trading wise) 21-day moving average.
Based on inclusive indications so far for the Dow, the S&P 100 and Nasdaq 100, in terms of making a top, the jury is still out on whether most sectors, including the big cap stocks, will start a significant downside pullback as is suggested by the broader S&P 500 and Nasdaq Composite. I currently think all areas will see further weakness.
GOOD TRADING SUCCESS!