Knowing when to exit a trade is arguably more important than knowing when to enter a trade.
I used to get extremely frustrated with trading, the market, and ultimately myself. I was the guy who’d be shaken out of trades and then watch them go on a tear without me. I was also the guy who’d overcompensate on his next trade and hold on way too long! Giving back meaningful gains… Has anything like this ever happened to you? It’s super frustrating isn’t it?!?
This is what prompted me to come up with plans A, B, C & D on every trade. I never wanted to be caught like a dear in the headlights again when the market started to move. Not succumbing to hope, fear, and greed.
I started to think of each trade I’d take like a movie.
You walk into the theater (pre-covid), pick the movie you want to see, get your ticket, maybe some popcorn and a drink, and grab a seat. You’ve heard good things about this movie. You like the genre. It has some of your favorite actors and actresses. You have high hopes and expectations for it. But you don’t KNOW if this movie is going to meet those expectations.
If the movie turns out to be a stinker halfway through, I used to be the guy who would sit there and grumble “I paid for my ticket so I’m sticking it out to the end.”
What I’ve come to realize is that theaters have multiple exits for a reason. If things go bad (there’s a fire, an emergency, or the movie stinks) you can get out in a hurry. Eventually, I learned to treat my trades the same way!
There are 4 exit strategies you need for every trade.
I also find it helpful to think of the first 3 strategies as ways I’m going to get paid. The 4th strategy is a cost of doing business and a way of keeping that cost small!
Plan A: Profit Target(s).
The trade works out well and does exactly what you wanted it to do. Hurray! Knowing where you’re going to allow the market to pay you and how much is important! If not, you run the risk of watching your gains evaporate.
What I like to do is when price hits my target, I’ll sell half. That way no matter what happens after that point, I’m a winner! (shout out to Mark Minervini for this idea). If price keeps running, then thank goodness I held onto half! If price moves against me after hitting my target, then thank goodness I sold half! Keeping a positive mindset (preserving our mental capital) is just as, if not even more important, than preserving physical capital. More on ‘Forging a Trading Mindset of STEEL’ here.
Plan B: Trailing Stop(s).
Trailing stops can get you out of trades that aren’t moving fast enough. If your trade becomes sluggish and isn’t maintaining enough momentum to keep above a certain moving averages, a trailing stop can get you out.
My trading style is momentum based swing trading. That means most of my winning trades are held for a few weeks to a few months. As such, I only want to be in the strongest names while they’re running higher. To help with that, I set 3 simple trailing stops to help keep me in trades while they’re running, and get me out when they start to fade.
The 3 trailing stops I use are:
- A weak close below the 5ema.
- A weak close below the 10ema.
- A weak close below the 21ema.
My trailing stops are meant to lock in gains so I’ll only use them once a trade has moved into profit.
Plan C: Back Stop(s).
Once the trade is moving in your favor, it should start to make new areas of price support. When it does, price should not fall back below it.
So, what is ‘support’?
Think of ‘support’ like this. You enter a building and walk up a flight of stairs. Now you’re on the 2nd floor. The new floor you’re standing on is support! It is supporting you and it SHOULD be sturdy! If it starts to break as you walk around, you’d want to get the heck out of there before you fall through it and get seriously injured! This same principle applies in trading.
New areas of price can come in a few ways. Here are two of my personal favorites:
- Price starts to move sideways for a few weeks while not making any significant new price lows.
- There is a large breakaway gap up on huge volume.
When either of these scenarios happen, if price starts to fall through ‘support’, I’ll exit some, if not all of the trade.
Plan D: Stop Loss(es).
While we’d all love for every trade to be a winner, unfortunately we will incur some losses along the way. Think of it as the cost of doing business. It’s up to us to decide just how costly we want our business to be. And don’t be fooled into thinking that if you don’t use stop losses, you’ll avoid this cost! Here’s what happened to a friend of mine many years ago who thought if he just held on a little longer, price would come back!
My friend and I bought Citi Group back 2008 when it was thought that they were ‘too big to fail’. I remember both of us getting in at about $10/share. Within a few days it was up to $11 and we were thrilled! But then, price started to move against us. Pretty soon, price was back at $10 and then dropped further to $9. I was still pretty early in my trading career back then but at leat I had the good sense to cut my losses. My friend, however, insisted that it would be back up in no time and that this was a buying opportunity.
Unfortunately for my friend, price dropped from $9, down to 8, 7, 6. and all the way down to about $5/share! He held on and was down 50% within a few months!
It’s on us to decide at what point we’ll cut a loss short. I find it best to determine at what point I’ll cut a loss short BEFORE I ever place the trade. It’s very easy to ‘give it a little more room’ or worse, ‘average down’ when trades move against us.
Think of the math… If you lose -10% on a trade, it takes 11% to get back to even. Not too bad. 1 winning trade and you’re likely right back on the horse. But if you lose -50% on a trade, it takes 100% to get back to even!
Now lets put all of this together. Check out the annotated chart below. Everything is highlighted for you.
Congrats! You’re now ahead of most traders!
But this is still the tip of the iceberg to successful trading. There’s many position sizing strategies, mindsets, styles of execution, and more that you’ll need to meet your goals. It will require some effort on your part but trust me, none of this is rocket science. If I can do it, so can you!
- Having an exit strategy is crucial for achieving trading success.
- The four exit strategies you need for every trade are:
- Profit Targets
- Trailing Stops
- Back Stops
- Stop Loss(es)
- Once the trade is moving in your favor, it should start to make new areas of price support. When it does, price should not fall back below it.
- Stop-loss prices and profit targets should be decided BEFORE the trade is ever placed.
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