I have a question that I need some clarification on regarding the channel breakout theory. My questions is that in the uppermark book they give an example that states that a trading signal (a buy signal) is generated when the price breaks the upper bound (channel) and that a sell signal is generated when the price breaks the lower bound. I believe the specific example states that to buy when the price hits $6.80 and to sell when the price hits $6.00. This makes no sense to me, to buy high and sell low how would this strategy generate any profits. Is there something that I am missing or over looking here? Assuming that the price will most likely converge to the long run mean wouldn’t you want to do the opposite of what the book says. Short the stock when it breaks the upper bound and buy when it breaks the lower. Thanks for your help in advance!
That’s why the channel breakout strategy is called trend following system. What you’ve referred to is called oscillators, of which they used to identify exhausted trend and will sell when prices are too high and buy when the prices are too low.
Thanks Philip. I understand that it is trend following strategy but how would this strategy turn a profit? I’m still a little fuzzy on the logic. For example if the stock price is following an up trend and you hit consecutive highs of say $6.80, 6.95, and 7.10 and you add to the position at each high with your lower bound staying unchanged at $6 where would the profit be generated? I think that the example in the book is pretty brief and poor.
I believe the book is only referring to entries (not exits) in terms of the buy and sell signals. This is straight from memory… I’m not sure if the book actually states otherwise. There are lots of strategies that follow a buy-on-strength and exit after, say, when the stock is significantly oversold (i.e., RSI > 90).
Thanks adalfu, I did some further research on my own and that’s what I found is that the strategy doesn’t really tell you when to exit and that’s what makes it susceptible to large losses in the event of a reversal of the trend. B/c of this problem I see why you would be useful to couple the channel breakout with maybe another strategy that might help mitigate the chances of the large losses.