Practice
Your Exit Strategy
| It's easy to get into the market, but what about
getting out? Most traders don't have an exit plan,
whether their positions are turning a profit or going
down in flames. The truth is that a good exit will save
your neck on a bad entry, and keep you in the game
longer than good stock-picking. |
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Exit planning must deal with the good, the bad and the
ugly. In other words, keep a profit protection strategy
to exit winning trades, a stop loss strategy to get out
of bad ones and a fire drill in case disaster strikes.
You'll need all three tactics in every trade, because
anything can happen once you hit the order button. |
| Your holding period guides the profit side of the exit
equation. Always seek the reward target that matches
your time in the market. In other words, trade the most
profitable move from your entry to the target within the
time frame that you're long or short the stock. This
lets you apply both a time- and a price-based exit
strategy to your winners. |
A time-based exit strategy requires little
interpretation. Focus on your holding period's time
window rather than the price action. Exit the trade
immediately when price hits the reward target at the
right time. Exit the trade before price hits the reward
target if the window starts to close. The trick with
time-based strategies is to look for the best price
available within the chosen window.
Most traders should start with a price-based exit
strategy. For example, you enter a long position, and it
moves into a profit. It rallies at a moderate pace and
hits your reward target within the holding period. You
exit the trade "blind" at the reward price. This means
you take the money and go, without considering the
current price action.
You've just taken a nice profit in a perfect world,
but how do you protect yourself in the real one? Start
by focusing on trends within shorter-term time frames.
For example, when trading a daily chart, manage profit
and loss using a 60-minute chart whenever possible. The
shorter-term pattern will tell you when to move the stop
in order to protect profits, or when to exit the trade
entirely.
Let's outline common stages for a long position that
eventually reaches the reward target:
- Price moves into a profit.
- Price reaches first resistance, and reverses.
- Price finds support and rallies through first
resistance.
This action/reaction continues until price reaches the
target. In this scenario, trade management requires a
breakeven stop as soon as price moves into a profit.
This stop should be moved up after the first reversal,
but stay below short-term support. When price finally
rallies above first resistance, move the stop just below
this new level. Continue the process until the position
hits the reward target.
Profits are nice, but many trades go haywire right
away. The exit strategy is very simple in this
situation: get out as soon as price breaks support on a
long trade, or resistance on a short sale. This may
sound simple, but there are two problems. First, many of
us lack the discipline to take losses when they should
be taken. Second, many of us don't understand how to
place stop losses in the first place.
Take your loss when the market says you're wrong. Every
setup has a trigger that violates the pattern you intend
to trade. Identify this price in advance, and place your
stop just behind it. Remember that this magic number
changes dynamically with each new bar, so you need to
adjust it often. But don't remove it under any
circumstances.
Do you get frustrated because your stops get hit
frequently on good trades? The fault lies in your
analysis and trade management, not in the stops
themselves. Many traders believe they can improve their
performance by placing stops where they shouldn't go.
Every stock will violate support/resistance up to a
point before reversing. Your analysis must consider the
stock's underlying volatility, so the stop can be placed
outside this "market noise."
Finally, you need a way to deal with unexpected bad
news. Start with a panic drill, and practice it over and
over again in your head. The exit strategy is simple: If
you can beat the rest of the crowd out of the door, act
immediately. The after-hours market can save you a
fortune if you learn to use it wisely. If you can't
escape right away, watch price action closely and take
your best shot. The market can do anything it wants once
bad news hits, and you may need to accept a large loss.
Sudden losses are a cost of doing business as a trader.
Full disclosure rules and external events will impact
your bottom line from time to time. Reduce your risk by
choosing lower-volatility stocks to carry over longer
time periods. Avoid holding anything through earnings
reports or terrorist threats. Remember, it's not hard to
rebuild profits after the unexpected takes a bite out of
your bottom line.
