Exits are one of the trickiest parts about trading. Timing them correctly is not easy. Either you will sell too early, and miss the majority move, and feel like shit. Or you had a nice unrealized gain and it comes all the way back to your entry price, and you feel even worse.
The best exit strategy will allow you to realize profits when you have them, keep you in a position to capture a bigger move, and prevent your trade from coming all the way back and turning into a loss. Here’s how I do it:
The Nature of Exits in Trading
Give up trying to sell the top. Jesse Livermore said it best: “The first ⅛ and the ⅛ of the move are the most expensive”. Before we can talk about exits, you have to get this mindset right. Never expect to catch tops or bottoms. Strive to catch the MEAT of the move. You can make great money in the markets by focusing on stocks that will move A LOT, and capturing a piece of the move.
If a stock has a large range, you only need to capture a fraction of it to make good returns. If a stock moves 10% on a day for example, and you capture 5%, that is a great return, even with just capturing half of the move. Focus on trading stocks that have large range, and a reason to trend in a particular direction. So what’s the best way to capture a piece of the move without leaving a lot of money on the table, and avoid having a gain reverse on you?
The Best Exit Strategy To Resolve This Issue
Scaling. This is my favorite exit strategy to deal with this trading quandry. Scaling is simply selling a portion of your position, usually for it’s either ½, ⅓ or a ¼ when I am up on a position in a stock, depending on how much further I think the stock can move.
When you sell part of your position, you realize part of the profit you have on the position, but you still have some of your position left to capture a bigger move in the stock. So what do you do after you take partial profits on a position?
Move Your Stop Loss Up
A very important component of my scaling strategy is moving my stop loss up to my buy price after I take partial profits. This allows me to minimize my risk on the trade and essentially keep it a winning trade even in the worst-case scenario. This prevents you from being in the scenario of the stock reversing on you and having a gain turn into a loss.
Yes, you can still sell too-early, and too late with scaling. But you significantly increase the probability of you preventing a winner turning into a loser with scaling, and good risk management with your stop loss.
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