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, 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.
Here are the 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 my friend and mentor 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 important, if not even more important, than preserving physical capital.
Plan B: Trailing Stop(s).
Trailing stops can get you out of trades that aren’t moving fast enough. If for example your trade becomes sluggish and isn’t maintaining enough momentum to keep above a certain moving averages, a trailing stop can get you out.
The key to a good trailing stop is to customize it to your personal style. 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. The trailing stops I use are a series of “Danger Signals” that tell me “Hey, momentum is fading. Time to cut this loose.”
Danger Signals are a topic worthy of their own post. To get us started, here’s a dozen that I’ll look for. When I see any combo of 7 or more of these, it will prompt me to exit completely, or aggressively raise my back stop.
- Price closes near daily low
- Price closes below the 10ema
- Price closes below a short term swing low
- Price closes below a 10 day 1.5 ATR
- Price has made 3 consecutive days of lower lows
- Any down day that closes lower than previous 3 bars
- Fast stochastic crosses below the slow stochastic
- Both fast and slow stochastic are curved down
- Outside reversal bar that pushes into fresh highs and closes near its lows
- Relative Strength Line (RS Line) curving down
- RS line negative short term
- RS line underperforming price short term
Here’s how this worked on ECPG. I had entered on July 12 and on August 2nd, 8 danger signals showed up… 2 days before price completely imploded!
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.
Here’s a recent trade in NINE. It was entered on December 20. See how the prior chart highs (ceiling) are now acting as the floor (support).⠀
Plan D: Stop Loss(es).
While we’d all love for every trade to be a winner, that’s just not how it works. This is why stop losses are important. Our only protection against a BIG loss, is by taking a small loss.
A friend of mine learned this lesson the hard way…
It was 2008. Stocks were imploding. Financial institutions were collapsing. And the government was rushing in to provide bail outs. One of the companies that to get bailed out was Citi Group.
I was naïve back then. My friend and I thought “too big to fail” was a great reason to buy shares in Citi. We both bought in at about $10/share. Within a few days it was up to $11 and we were thrilled! Drinks all around!
…But then, price started to move against us. Within a week, price was back at $10 and then dropped further to $9.
Even though cutting losses was still a new idea that I was still warming up to back then, I grit my teeth and cut the losses. Losing 10% wasn’t fun, but it was better than what was about to happen next.
Price continued to drop from there. From $9, down to 8, 7, 6. and all the way down to about $5/share! I was long gone…
Unfortunately my friend decided to hold on… and was down 50% within a few months!
It’s on us to decide at what point we’ll cut a loss short. The best time to figure this out is BEFORE the trade is executed. The reason why is because its all too easy to say “Meh, lets give it a little more room” and rationalize holding on to losses.
Or worse… Thoughts of “Hey, the market is throwing a sale! If we liked it at $10, buying more at $7 is a bargain!” This is the exact opposite of what you should be doing.
Think of the math… If you lose -10% on a trade, it takes 11% to get back to even. Not too bad. One winning trade and you’re right back on the horse.
But if you lose -50% on a trade, it takes 100% just to get back to even!
Implement these for strategies and you’ll be well ahead of the curve!
But this is still the tip of the iceberg to successful trading. There’s 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.