Simple and effective exit trading strategies
Traders spend hours fine-tuning their entry strategies, then explode their accounts by taking bad exits. In fact, most of us lack effective exit planning, often getting shaken up at the worst possible price. We can remedy this oversight with classic strategies that can improve profitability.
Before we jump into strategies, let’s start by seeing why the holding period is so important. Next, we’ll cover the poorly understood concept of market timing and then move on to stop and scale methods that protect profits and reduce losses.
Key points to remember
- Many traders design solid exit strategies, but don’t follow through when it comes time to act; the results can be devastating.
- When developing your plan, first calculate the reward and risk levels before entering a trade, then use these levels as a template to exit the position for the best price, whether you profit or take. a loss.
- Market timing, an often misunderstood concept, is a good exit strategy when used correctly.
- Stop-loss and scaling methods also allow savvy and methodical investors to protect their profits and reduce their losses.
It’s impossible to talk about exits without noting the importance of a holding period that works well with your trading strategy. Magic timeframes roughly correspond to the general approach taken to withdrawing money from the financial markets:
Pick the category that best matches your approach to the market, as it dictates how much time you have to account for your profit or loss. Stick to the settings, or you risk turning a trade into an investment or dynamic play into a scalp. This approach requires discipline because some positions perform so well that you want to keep them beyond time constraints. While you can stretch and shorten a holding period to accommodate market conditions, taking your exit within parameters builds confidence, profitability, and trading skills.
Get in the habit of setting reward and risk goals before entering into every trade. Look at the chart and find the next level of resistance that might come into play within the time constraints of your holding period. This marks the reward goal. Then find the price you’ll be wrong at if the headline flips and hits it. This is your risk objective. Now calculate the reward / risk ratio, looking for at least 2: 1 in your favor. Anything less, and you should skip the trade, move on to a better opportunity.
Focus trade management on the two key exit prices. Suppose things are going the way you want them to and the prize progress is getting closer to your reward goal. The rate of change in price now comes into play because the faster it reaches the magic number, the more flexibility you have to choose a favorable exit.
Your first option is to take a blind exit to the price, congratulate yourself on a job well done, and move on to the next transaction. A better option when the price moves strongly in your favor is to let it exceed the reward target, placing a protective stop at that level as you try to add gains. Then look for the next obvious barrier, staying positioned as long as it doesn’t violate your holding period.
Slow cash advances are more difficult to trade as many securities will approach but will not meet the reward target. This requires a profit protection strategy that starts after price crosses 75% of the distance between your risk and reward targets. Place a trailing stop that protects partial wins or, if you are trading in real time, keep one finger on the exit button while you watch the ticker. The trick is to stay positioned until the price action gives you a reason to exit.
In this example, Electronic Arts Inc. (EA) shares sold in October, breaking the August low. It goes up the support two days later, issuing a 2B Buy signal, as defined in the 1993 classic “Trader Vic: Methods of a Wall Street Master”. The trader calculates the reward / risk as follows, predicting an entry close to $ 34 and a stop-loss just below the new support level:
- REWARD TARGET (38.39) – RISK TARGET (32.60) = 5.79
- REWARD = REWARD TARGET (38.39) – ENTRY (34) = 4.39
- RISK = ENTRY (34) – TARGET RISK (32.60) = 1.40
- REWARD (4.39) / RISK (1.40) = 3.13
Position is doing better than expected, exceeding the reward target. The trader responds with a profit protection stop just to the reward target, increasing it every night as long as the upside makes further headway. (See also Play the gap.)
An effective exit strategy builds confidence, business management skills and profitability.
Stop loss strategies
Stops should go where they take you out when a title violates the technical reason you took the trade. This is a confusing concept for traders who have learned to place stops based on arbitrary values, like a 5% withdrawal or $ 1.50 below the entry price. These investments are meaningless because they are not suited to the characteristics and volatility of that particular instrument. Instead, use technical feature violations, such as trend lines, round numbers, and moving averages, to establish the natural stop-loss price.
In this example, Alcoa Corporation (AA) stock is soaring in a steady uptrend. It is stagnating above $ 17 and reverting to a three month trendline. The ensuing rebound returns to the highest, encouraging the trader to take a long position, in anticipation of a breakout.
Common sense dictates that a breakout of the trendline will prove the rally thesis wrong, demanding an immediate exit. Additionally, the 20-day Simple Moving Average (SMA) has aligned with the trendline, increasing the chances that a violation will attract additional selling pressure.
Modern markets require an extra step in the efficient placement of stops. Algorithms now consistently target current stop-loss levels, rocking retail players and then jumping back through support or resistance. This requires that the stops be placed away from the numbers that indicate you are wrong and must exit. Find the perfect price to avoid these stop shopping is more art than science.
Typically, an additional 10-15 cents should work on a low volatility trade, while a dynamic play may require an additional 50-75 cents. You have more options when watching in real time as you can leave your original risk target and come back if the price crosses above the contested level.
Exit strategies at scale
For a scalable exit approach, increase your stop to break even as soon as a new trade becomes profitable. It can build confidence because you now have free trade. Then sit back and let it run until the price reaches 75% of the distance between the risk and reward targets. You then have the option of leaving all at once or in pieces.
This decision follows the size of the position as well as the strategy employed. For example, it does not make sense to split a small trade into even smaller parts, so it is more efficient to find the best time to empty the entire stake or apply the stop-at-reward strategy.
Larger positions benefit from a multi-level exit strategy, exiting one third at 75% of the distance between risk and reward targets and the second third at target. Place a back stop behind the third piece after it passes the target, using this level as an exit to the bottom if the position turns south. Over time, you will find that this third coin is a lifeline, often generating a substantial profit.
Finally, consider an exception to this multi-level strategy. Sometimes the market gives out gifts, and it’s our job to pick the fruits at hand. So when a topical shock triggers a big deviation in your direction, exit the whole position immediately and without regret, following the old wisdom: never look a gift horse in the face.