Traders dedicate their time to perfecting their entry strategies but then blow out their accounts due to poor exit strategies. While exit planning is one of the most important aspects of trading, most people trading stock lack effective exit planning and frequently get shaken out. For instance, many traders enter a trade without any type of exit strategy and loss it all or, at best, take premature profits.
As a trader, you need to understand what exits are available to you and try to create an effective strategy that will help secure profit and limit risk. In this article, we’ll discuss effective trading exit strategies that will help you lock in profits and minimize losses.
Stop Loss Strategies
This is an order that allows traders to automatically exit a particular trade at a prearranged level that is not as satisfactory as the existing market price. If you open a long position, you will need to place the stop loss at a price lower than when you enter the trade. And it will be higher for short positions. Stop-loss strategies can help you manage risk in a fast-moving market.
However, the downside of utilizing a stop-loss strategy is that it is under the influence of slippage. This is the market moves in the period it takes to execute your order. While there are different types of stop losses, Guaranteed stops and Trailing stops are the most basic option.
Guaranteed stops: This make sure your position closes at your pre-selected price. Guaranteed stops remove any risk of slippage, which is the situation in which the execution price you receive doesn’t match the price intended.
Trailing stop loss: This is the condition under which you move your exit price to secure profits but hold down if the market decides to moves against you. For instance, you buy a particular stock at $100, and you have your stop loss at $95. When the stock goes up to $102, the stop loss moves will move up to $97. While the price may keep rising, the price will eventually pull back to hit your stop loss.
Trade With a Profit Target
Before entering any trade, you need to get into the habit of establishing where to get out of a trade. You can calculate this using the risk/reward ratio. While you may not know which trade will be winner and loser before taking them, over many trades, you are more likely to see an overall profit if your winning trades are more than that of your losing trades.
When you trade with a profit target, you can assess whether a trade is worth taking. If the potential of the profit doesn’t outweigh the risk, you may want to avoid taking the trade. This way, creating a profit target can help you filter out risky and poor trades.
Risk-reward Ratio (RRR)
When planning a trading exit, you will need to understand your risk-reward ratio. RRR shows how much a trader feels comfortable losing compared to the profit they would get on the trade. Some of the most common risk-reward ratios you may want to consider include 1:2 and 1:3, while 1:1 is considered too risky. RRR will allow you to clearly understand the potential risks you may have to take on a trade to achieve your profit target.
In theory, this strategy is simple and effective. The challenges come when you are trying to make it all work together. For instance, you still need to set your target where it will likely be triggered. No matter how solid your reward risk is, it won’t count if the price is improbable to reach the potential profit target. Keep in mind that a favorable reward risk, with a good target, also needs a good entry strategy.
This is usually used with other trading exit strategies. The trading exit strategy allows you to close a trade before reaching your target or stop loss, but only under certain circumstances. Since most day traders don’t usually hold their positions overnight, so it’s practical to close all positions by the end of the trading day, no matter whether you make a profit or loss. Besides, you may want to close all positions a few minutes before a huge economic news release, especially if you are a day trader.
Trading exit strategies can greatly improve your trading by reducing risk and help you make a profit. Remember, you don’t need perfect trading exits to make money from your trades. All you need is a positive expectation over a set of trades. After achieving that, you can aim to scale up your position size cautiously.