Last week I had a blast writing about some of great times that I’ve had with Chuck LeBeau, who was recently presented with a Lifetime Trading Achievement Award.
Today, I’d like to continue to share some of Chuck’s goodness with you—this time from the technical tools and tricks I’ve learned from him.
Van did a great job last week outlining several areas of Chuck’s extensive technical repertoire (Read last week’s article). Today, I’d like to share my experience and practical application of a few of those many great contributions.
The Trend Is Your Friend but It Doesn’t Always Announce Its Arrival
One of my favorite parts of Chuck’s excellent book Computer Analysis of the Futures Markets was the conclusion drawn after he and David Lucas had tested thousands of pairs of moving averages. Simplifying a bit, they concluded that in a trending market just about any length moving average crossover system worked just fine, but in choppy or sideways markets, those same strategies get chopped up and lose money.
For today’s systems oriented people that’s obvious. However, Chuck and his co-author were among the first to popularize the notion and support it with hard data.
So the question became “If these things are very robust in trending markets and stink pretty broadly in sideways markets, how do we tell one market condition from the other?” Chuck’s research led him to Welles Wilder’s ADX.
Chuck did some pioneering testing on the ADX, and I believe it’s fair to credit him with furthering the use of RATE OF CHANGE in ADX as it’s most important aspect, rather than the absolute value of ADX, which was (and still is) broadly used.
From a practical application standpoint, I have tested and traded systems that use the ADX indicator as an absolute value style on/off switch. In other words, if ADX is above thirty, enable the trade, if it’s below 30, disable.
Almost always, the use of an ADX in a rate-of-change mode improved the performance characteristic of the strategy. Your mileage may vary, but this is still a very powerful tool that I use in several swing trading strategies.
Exits, Exits and More Exits
Chuck was the first person who gave me permission to use multiple exits for a single entry. For those of you not familiar with this concept, after entering a trade, you can have many different ways to exit:
a trailing stop.
a multiple ATR profit target exit (this exit allows you to take advantage of an unexpected extreme move in your favor).
a parabolic exit (this exit will be much further away than your trailing stop at the beginning of the trade, and then moves closer to protect profits as the trade matures).
In short, when it comes to exits, one size does not fit all. And for many systems, a multiple exit strategy will help optimize performance.
I think one of the most important lessons that I learned from Chuck is the evaluation of exit efficiency. When we’re trying to establish the efficacy of a trading system, it’s important to understand the individual contributions made by the component parts of the system; a good exit strategy can be obscured by a weak set-up and vice versa.
Chuck introduced me to the idea of measuring exits efficiency. To do that, he suggested that one should look at each trade and compare the profit/loss for the trade with the maximum profit that could be made if you held the trade twice as long. If your exit strategy is averaging less than 50% of the maximum potential profit, then the exit plan needs some work. Anything over 50% is a useful and efficient exit strategy. With that knowledge in hand it becomes much easier to know which parts of your system need work, and which don’t.
Chuck—congratulations again on your well-deserved lifetime achievement award. The accolade could not have gone to a nicer guy. Thanks for all you’ve done to further my knowledge and experience in the game of the financial markets that you love so much! It’s so clear that your legacy will be that of a man who gave much more than he received.