Traders spent hours fine-tuning their entry strategy, but then exited their accounts by mistake. In fact, most of us lack an effective exit plan and are often eliminated at the worst price. We can make up for this oversight with classic strategies that can improve profitability.
Before we get into the strategy, let’s take a look at why the holding period is so important. Then we will enter the misunderstood concept of market timing, and then turn to stop loss and scaling methods that protect profits and reduce losses.
- Many traders devise strong exit strategies but fail to stick to them when they act; the results can be devastating.
- When making a plan, first calculate the level of return and risk before entering the trade, and then use these levels as a blueprint to exit the position at the best price, whether you are making a profit or losing.
- Market timing, a concept that is often misunderstood, is a good exit strategy if used properly.
- Stop-loss and scaling methods also enable savvy, methodical investors to protect profits and reduce losses.
If you do not pay attention to the importance of holding periods that work well with your trading strategy, it is impossible to talk about exits. The magical time frame is roughly consistent with the wide range of methods chosen to withdraw funds from financial markets:
Choose the category that is closest to your market approach, as this determines how long you must record your profit and loss. Stick to the parameters, otherwise you will run the risk of turning trading into investment or momentum game into a scalp. This method requires discipline, because some positions perform so well that you want them to be free from time constraints. Although you can extend and squeeze the holding period according to market conditions, exiting within the parameters can build confidence, profitability and trading skills.
Get in the habit of establishing reward and risk goals before entering each transaction. Look at the chart and find the next resistance level that may come into play within the time limit of your holding period. This marks the reward goal. Then find the price, and if the security turns and hits it, you will be proven wrong. That is your risk goal. Now calculate the return/risk ratio and look for at least 2:1 to benefit you. With less, you should skip trading and move to better opportunities.
Focus trade management on two key exit prices. Let us assume that things are going your way, and the rising price is moving towards your reward goal. The price change rate 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 blindly exit in price, pat yourself on the back for doing a good job, and then move on to the next transaction. When the price trend is strong in your favor, a better option is to let it exceed the reward target and set a protective stop loss at that level when you try to increase your profit. Then look for the next obvious obstacle and keep the position as long as it does not violate your holding period.
Slowly advancing trading is more tricky, because many securities will approach but not reach the reward target. This requires a profit protection strategy that will be activated once the price crosses 75% of the distance between your risk and return goals. Set a trailing stop loss to protect part of your profits, or, if you are trading in real time, please place a finger on the exit button while watching the stock market. The trick is to stay positioned until the price movement gives you a reason to exit.
In this example, the shares of Electronic Arts Corporation (EA) were sold off in October, below the August low.Two days later it reinstalled support and issued 2B buy Signals, as defined in the 1993 classic “Trader Vic: The Method of Wall Street Masters”. The trader calculates the return/risk as follows, planning to enter the market near $34 and place a stop loss below the new support level:
- Reward target (38.39)-risk target (32.60) = 5.79
- Reward = reward goal (38.39)-entry (34) = 4.39
- Risk = Entry (34)-Risk Target (32.60) = 1.40
- Reward (4.39) / Risk (1.40) = 3.13
The position is better than expected and higher than the reward target. The trader responds with a profit protection stop loss on the reward target and increases it every night as long as additional progress is made on the upside. (Also take a look Play gap.)
An effective exit strategy can build confidence, trade management skills and profitability.
Stop loss strategy
When securities violate the technical reasons for your trading, the stop loss needs to be where they let you withdraw. For traders who are taught to set stop losses based on arbitrary values, this is a confusing concept, such as a 5% retracement or $1.50 below the entry price. These configurations are meaningless because they are not adjusted according to the characteristics and volatility of a particular tool. Instead, use violating technical characteristics (such as trend lines, integers, and moving averages) to establish natural stop-loss prices.
In this example, Alcoa’s (AA) stock is moving higher in a steady upward trend. It stayed above $17 and fell back to the three-month trend line. The subsequent rally returned to highs, encouraging traders to enter long positions in anticipation of a breakthrough.
Common sense suggests that a trend line break will prove that the rebound argument is wrong, requiring immediate exit. In addition, the 20-day simple moving average (SMA) has been aligned with the trend line, which increases the possibility that a breach will attract additional selling pressure.
Modern markets require additional steps to effectively set stop losses. Algorithms now usually target common stop loss levels, shaking retail players, and then jumping back to support or resistance. This requires the stopping point to stay away from the numbers that say you are wrong and need to leave.Looking for the perfect price to avoid these Stop running It’s not so much science as it is art.
As a general rule, 10 to 15 cents should be added in low volatility trading, while momentum trading may require an additional 50 to 75 cents. You have more options when observing in real time, because you can exit at the original risk target, and re-enter if the price jumps back to the disputed level.
Expand exit strategy
For the extended exit method, once the new transaction makes a profit, increase the stop loss to achieve a breakeven. This can build confidence because you now have free trade. Then sit down and let it run until the price reaches 75% of the distance between the risk and reward targets. Then, you can choose to exit at one time or in stages.
This decision tracks the size of the position and the strategy used. For example, it does not make sense to divide small transactions into smaller parts, so it is more effective to find the most suitable time to sell all shares or apply a stop loss strategy.
Larger positions benefit from a tiered exit strategy, exiting one-third at 75% of the distance between risk and return targets and one-third at the target. After the third block exceeds the target, place a trailing stop after the third block. If the position turns to the south, use this level as the bottom exit. Over time, you will find that this third product is a life-saving straw that usually generates considerable profits.
Finally, consider an exception to this layering strategy. Sometimes the market will give out gifts, and our job is to pick the fruits that are at our fingertips. Therefore, when the news shock triggers a considerable gap in your direction, immediately exit the entire position, do not regret it, and follow the old wisdom: never put a gift in your mouth.