Today we are going to discuss trading exit strategies with a specific emphasis on initial stop-loss and take-profit targets. While on a recent flight, I was reminded during the safety speech/demonstration to look around and find the nearest exit and become aware of the any alternate exits from my seat. Now, many people, including myself, have been guilty of “tuning” this safety speech out and not paying too much attention. However, on this occasion I started thinking about the application of the safety tips of flying to my trading. While entering trades is important, understanding were you are going to exit is perhaps even more important than the entry.
Defining your exit strategy
Traders without good exit procedures in place are really just hoping for a good outcome to that trade. Successful traders plan out their exits by setting initial stop-loss and take-profit targets. Stop-loss and take profit points represent two key ways in which you can plan your exits.
On the other hand, unsuccessful traders often enter a trade without having a good idea of at what points they will exit the trade at a profit or a loss. Like gamblers on a lucky or unlucky streak, emotions begin to take over and dictate their trades. Losses often provoke people to hold on and hope to make their money back, while profits often entice traders to be greedy and hold on for even more gains.
Planning exits with Initial Stop-Loss and Take-Profit Levels
An initial stop-loss point is the price at which a trader will close a position and take a loss on the trade. Often times, this happens when a trade does not go the way you had hoped. The initial stop loss point is designed to prevent the “it will come back” mentality and will limit losses before they get overwhelming. For example, if long in a stock and it breaks below a key support level, it is often a good time to close the position.
On the other side of the table, a take-profit point is the price at which a trader will sell a stock and take a profit on the trade. Often times, this is when there is limited additional upside given the risks. For example, if a stock is approaching key resistance level after a large move upwards, traders may want to sell before a period of consolidation takes place.
How to effectively set Initial Stop-Loss Points
One good way to determine stop-loss or take-profit levels is based on support and resistance levels that can be drawn by connecting previous highs or lows that occurred on significant, above-average volume. A trader can also use longer term moving averages to help establish potential support and resistance levels. The key to determining the best initial stop loss is to determine solid support and resistance levels and to set them just inside these levels by 1/2%.
The important thing to remember is to never place a trade before you determine what your possible exits will be. Know in advance where you are going to place your initial stop loss to keep your losses to a minimum, if the trade goes against you. And place your profit target where you are willing to take a profit when the trade goes in your favor.