How many times in a trade do you ask yourself: Should I get out of my trade here? Did the trend change? Is my winner going to turn into a loser? One of the most common questions we get: “How do you know when to exit a trade?” Most traders’ exits are the reason why they cannot consistently make money. They either exit too late and take a huge loss, take profits too soon, or let big unrealized gains evaporate. Here are some strategies for improving your trade exits so you can increase the size of your winners and decrease the size of your losers:
Understand How Stocks TrendWhen you understand technical analysis, you understand why stocks move from one price area to another. Traders who don’t understand or use technical analysis will see price action as random. They will buy stocks at major resistance and wonder why the stock immediately reversed on them. Understanding where key support and resistance levels are before you enter a trade is essential, as they determine the best areas to exit your position. Novice traders get in a trade and don’t know what their target or stop loss is on the trade. You ALWAYS need an exit plan going into a trade, and prepare for the possibility of the trade being a loser. In general, you want to be selling your positions (or partials) at resistance areas, and buying/covering at support areas.
Letting Winners RunOne of the biggest misleading trading cliches: “You cannot go broke taking profits.” You actually can. Early profit-taking will skew the risk vs reward ratio on your trades, and make it harder for your winners to cancel out your losers. Here’s how: Let’s say your risk vs reward ratio on all of your trades is 1:2 and your win rate is 50%. Your winners are on average $400, and your losers are on average $200. If you start taking early profits at $200 because you are getting scared your winners will turn to losers, your risk vs reward ratio will become 1:1. This means you go from becoming a profitable trader to a breakeven trader (losing money after commissions). Early profit-taking is also painful because you left money on the table. The better you are at letting your winning trades run, the less you need to worry about having a high win percentage. Letting winners run is just as important as keeping losers small. For more tips on how to let winners run, check out this article here.
Make A List of Reasons To SellYou cannot sell your positions because you are emotional. You need to have technical or fundamental reasons to exit your positions. Here some reasons why you should exit a trade:
- Your stop loss is triggered
- You’re long or short and the stock is approaching its 200 SMA.
- You’re short and the stock is approaching a major daily support level.
- The stock is trading at 5x its normal daily range and is overextended
- The stock is reporting earnings the next day (Never hold big positions through earnings reports)