Chandelier Exit Indicator: How the Adaptive Trailing Stop Works

Mechanics of Chandelier Exit Calculation and Settings

The Chandelier Exit indicator is a dual-line tool that can be used for both short and long positions, providing clear signals for when to exit a trade. It’s essential to understand that while the Chandelier Exit prompts you to close your position when triggered, it’s not a signal to immediately enter a trade in the opposite direction.

Let’s look into the adjustable settings that help tailor the Chandelier Exit to your trading style:

• Lookback Period: This determines how far back in the price history the indicator will go to find the highest high or the lowest low. It sets the stage for the calculation.
• ATR Multiplier: Typically set at 3, this figure multiplies the Average True Range (ATR), establishing the distance from the highs or lows at which your stop will be set.

Charles Le Beau, a pioneer in systematic trading, suggests a default setting of a 22-bar period with a multiplier of 3 for the Chandelier Exit.

The formula for the indicator is straightforward, though it’s usually computed automatically by your charting software:

• For a Short Position: Chandelier Exit = (Lowest Low over n bars) + (ATR(n) * Multiplier)
• For a Long Position: Chandelier Exit = (Highest High over n bars) – (ATR(n) * Multiplier)

Adjusting the ‘n’ value can be a delicate balance. Set it too close, and you risk being stopped out by normal market noise. Set it too far, and you may give up excessive profits if the market turns against you.

The goal is to fine-tune these settings to capture maximum gains while ensuring you exit trades when the market conditions have evidently shifted. It’s about striking that balance between securing profits and mitigating risk.

Using Chandelier In Uptrends

As the price of the instrument makes higher highs and higher lows, you are in an uptrend and looking for long trading positions. That is the simple price action definition of an up trend in the market.  Being able to stay in the trade while the uptrend is intact, is a good use of the indicator.

In this daily chart example, we have a breakout trade entry from a double bottom and a trend line break.

As the stock continues to trend higher, the indicator tracks underprice.  On the right side of the chart, you can see the final stop location before the selloff happened.

As a trader, you may have a buffer zone below the Chandelier to avoid getting taken out of your position by simple fluctuations in price.  Part of your trading plan would include your decision to exit on a touch of the line or a specific price under the line.  While some traders may exit at close, this runs the risk of a large move against you before you exit.

The easiest way to use the indicator is to trail the stop after the period closes and continue to lock in gains before the stop price is hit.  In this case, the stock ran 66% before exiting.

Chandelier Exit In A Downtrend

Here we have a price action downtrend and also an upsloping trend line break.  Assume you enter short on the break of the trend line and your initial stop is at the red line above the entry.

As long as the price continues to make lower lows, the stop will continue to be adjusted helping you lock in gains.  Notice on the right, as the price forms a trading range, the red chandelier stop line has not moved.  Your stop would be at the red line looking to lock in a 6% gain on this short trade once the price crosses the line.

The Moving Average Trailing Stop

The moving average trailing stop is a popular method and let’s compare it to the Chandelier.  This stop-loss method utilizes a moving average of the price to trail the stop level. Traders will typically take a simple moving average of the closing prices over a set period like 20 or 50 bars.  As the moving average trails the price action, it acts as the adaptive trailing stop. When the price reverses and breaks back through the moving average by a set amount, the stop is triggered.

Advantages:

• Smooths out market noise since it trails a moving average, not just the high/low price directly. This helps avoid premature stop-outs.
• Easy to implement in most charting platforms. Simple moving averages are a standard indicator.
• Provides flexibility in tailoring the length of the moving average and distance for the stop trigger.

Disadvantages:

• Can lag trends and give back more profits compared to a true price-based trailing stop.
• Requires careful optimization of the moving average length and stop trigger distance.
• May not adapt as well to expanding volatility like a Chandelier Exit can.

This method serves as a straightforward, smooth approach to trailing stops. However, it tends to lag price more than volatile-based methods. The Chandelier Exit has advantages in strongly trending markets. Comparing and contrasting the two approaches to decide which one fits your trading strategy the best.