Exit Strategy – Get Out When Trades Don’t Work
What really matters at the end of the trading day?
Profit and loss (P&L) – how much capital is left in the account – drives all aspects of trading.
Often traders are more concerned with finding trades and don’t focus on an exit strategy to get out when trades don’t work. A carefully planned exit strategy helps protect capital.
Build an exit strategy for trades that don’t work
Traders must learn to be disciplined and unemotional when trading. Confidence in a trade setup can quickly turn to doubt when that trade isn’t working out as expected. Questions quickly form around exiting at a stop loss or holding on to the trade, hoping it works out.
Traders should have a “line in the sand” built into their strategies that indicates it is time to exit a trade.
There is truth to the old adage, “Making money is the easy part. Keeping it is the hard part.”
This is why a trading plan is so important.
Have a working trading plan in place
Traders should have a specific trading plan in place for each and every trade. Plan the strategy, the time frame, and know the targets. Traders need concrete numbers around the plan and the trading strategy they use to support every action they take.
Concrete numbers include the profit target in dollars and risk-to-reward percentages. Keeping those numbers visible throughout the trade helps maintain focus on what is needed for a winning setup.
For example, if a trade costs $5,000 traders should understand what they are willing to risk. Perhaps the trader is willing to lose $500 on that trade, which sets a P&L risk at $4,500.
While the reasons can vary that cause a trader to exit a trade, the P&L is the most important. When a trade hits a pre-established risk target, that is the sign to exit the trade.
Should traders choose a limit based on percentages of the potential loss. Traders then need to have a set percentage number in place for maximum loss. The established maximum loss becomes how far you are willing to let that trade move against your trading position.
Follow signals to exit losing trade
The signal to exit a losing trade can be indicated by unexpected events, also.
There will be times when a fundamental change in a company or industry occurs in the middle of a trade. Simpler’s traders know this can throw a wrench in even the best trading plans and should consider this as a sign to exit a trade.
Found on the calendar each quarter, earnings reports are one way to establish a “line in the sand” – an exit strategy or signal.
Traders can watch earnings reports for guidance on how a stock might perform. Once a trade setup is established based on expected earnings, if the report goes against your trade, a quick exit should be considered. Fundamental changes in the direction of a company, such as a new CEO or failure of a product launch, can indicate problems.
Traders should also consider exiting a trade when analysts downgrade a stock or industry based on a fundamental change in the company, sector, or economy.
Technical analysis – follow the charts
Simpler’s traders rely on a variety of stock chart indicators to build and maintain a setup for trades.
These indicators are useful, not only for trade setups and execution, but to signal trades that fall short of expectations.
(Check out the video, above, for insight into when to exit losing trades.)
Fibonacci levels can reveal red flags that indicate a possible exit for a trade. If support at these levels does not hold, it’s a solid signal that a trade may not be moving as planned and traders may need to get out.
Traders can also use Voodoo Lines® and Elliott Wave levels that work well to assess price movement. The Voodoo Lines® monitor price movement to the upside and traders use this indicator to watch for turns in stock price movements. Should any lines break at a predetermined level, this indicates an exit point.
Simpler’s traders follow the 8- and 21-simple moving average (SMA) signals on stock charts to gauge a turn in market direction. When the 8-SMA crosses below the 21-SMA, this indicates a turn in market direction that could move to the downside. Likewise, these signals can cross back to the upside. Both crossovers can have signals that you need to adjust or exit trades based on your position and how the market shift affects the trades.
Another exit signal that traders can use is the average true range (ATR). The ATR on stock charts is based on mean price (average price) and may indicate a reversion to the mean. Movement too far away from the mean – up or down – may signal it is time to exit a trade.
Find your combination of signals
Simpler’s traders use a combination of stock chart indicators as alerts that trades may not be working as expected. This allows traders to follow a trading plan with concrete measurements that can keep emotions at bay and help minimize risky actions.
When a trade is not looking good, turn to the plan in place and “follow the numbers” before acting too quickly. Sticking to pre-set limits for a trade helps set up exits when needed.