Knowing when to escape is no less important as knowing when to enter.
Experts some real, most self-appointed present tips about ‘undiscovered stock market gems', ‘inevitable price rises' and ‘must have commodities' everywhere on the internet. Curiously enough, 95 percent of these tips only provide entrance points and most of them are about purchasing stocks, bonds, commodities , etc. That's because most people favor to theorize on rising stocks and the ‘experts' are pleased to oblige. On top of that, institutional traders usually have a buy & hold strategy and would like other traders to maintain to the same strategy, because it creates balance. These are just a few of the reasons why exit methods often receive less consideration than they should.
Infamous Examples Of The Lack Of An Exit Strategy
The lack of a reliable exit strategy has been the trigger of extreme blunders both inside and outside the financial community. It would seem to be the case that loss aversion is such a basic part of human nature that even very intelligent and knowledgeable people are ready of making foolish decisions because of it. Let's look at some to illustrate the point.
Example 1: World vs. Credit Crisis
The credit crisis of 2008 placed financial sectors globally into a free fall. After the crash of Lehman Brothers almost all banks were at risk, and over the course of just a few of days the world found it really could not manage the collapse of any more big banks. Capitalism's default Darwinian exit tactic of survival of the fittest will no longer seemed feasible for a banking sector that was at the heart of all other business sector.
Without anyone noticing a new circumstance had surfaced where tens if not hundreds of worldwide banks turned out to be ‘too big too fail'. It was the new ‘get out of jail free' card for some of the wealthiest organizations on earth.
Capitalism's new exit strategy? Keep those corporations going no matter what (in other words: no exit strategy at all).
Example 2: the US vs. the Rest
The US military doesn't enjoy exit strategies. It would most likely refuse this (then again, maybe not) but looking at the intrusion of Normandy in 1944, and the wars in Vietnam, Iraq and Afghanistan, you cannot help but think the US military is incapable to bear the idea of retreat, even if it appears to be the wise thing to do. In Normandy the gamble paid off, though military experts claim that it was a close call. Nevertheless, in the decades since, this no escape policy didn't always pan out that nicely, at the cost of a lot of lives and treasure. Usually, Plan B for the US military would seem to be simply doubling down, in dreams of turning the tide in the end.
Example 3: Oil price vs. Hedge funds
The moderately sudden fall of the oil price in the summer of 2008 introduced several hedge funds to the verge of bankruptcy and some even over. The reason, reported by analysts from the Financial Times (among others), was their method to buy more oil when prices were dropping, rather than taking a loss on ventures going bad. Doubling down when prices are falling has the benefit that the benchmark (the average purchase price) will also fall, but when the price decline remains, the losses could obviously rise to massive proportions.
Exit Strategy To Limit Losses: The Stop Loss
Like Matt Damon claimed in the poker film Rounders: “You can't lose what you don't put in the middle.” In trading along with poker, limiting your losses is just as vital as maximizing your profits perhaps even more crucial. Every trader has losing trades once and awhile, and every dollar preserved in a losing trade is well worth just as much as a dollar gained in a profitable trade. It's as a result important to come up with an exit strategy before you open a position. Consider the reason why you want to open the position and base your stop loss on the answer.
You are an intra-day trader and utilize two back to back, 15 minute candles, going in the same path as your primary trade trigger. The aim is to earn 40-80 pips, which is very practical during small, intra-day trends in the Majors. You're not a top & bottom picker, but rather like to enter on the trade when the price activity has been under way for some time. In small, intra-day trends, retracement is usually restricted, so there's a good possibility of a clear move.
You set your stop loss depending on retracement within similar intra-day trends, previously in the day. You get thoseretracements from 5 minute candlestick charts. For example, you may well spot that throughout an earlier intra-day trend, there was a momentary retracement of two small candles of around 15 pips in total. And then, the intra-day trend re-established itself. Taking a sign from that scenario, you place your stop loss at 20 pips. You reason that a little retracement is always feasible, but that when it surpasses 20 pips, the possibility that the intra-day trend is going to reverse swiftly increases. Mind that this is a quite tight stop, but even if you are correct only 50 percent of the time you would still earn money, even if your winning trades would never go beyond 40 pips in profit per trade.
You are a short-to medium term trader and generally maintain your positions open for no more than a week. During that week your target is to capture part of a pattern that had previously been under way. You favor going long simply due to the fact you prefer rising prices and find it challenging to forecast on falling prices. Most of the time, you place on a position just after prices retraced a bit. The retracement has to be over though, raising your probabilities of good results to hook to the upward trend. Your profit targets are generally at 200 – 300 pips.
You prefer to place your stops just underneath the lowest point of the retracement. This is rational, because if the price turns again, going under the earlier retracement, there is a better chance that the trend is over and a period of ranging prices is setting in followed perhaps by a trend reversal. Whatever the case the situation would be too unclear to take sides. You know this set-up produces a winner about 30% of the time, and your stops are typically about 50 – 80 pips away. So, normally, you will lose 2x 65 = 130 pips and you will earn about 250, for a regular profit of 120 pips per three trades, or 40 pips per trade.
Exit Strategy To Secure And Maximize Profits
Because not every trade can be a winner, it's all the more essential to ensure the winning ones are as rewarding as conceivable. Or, as the saying goes: ‘cut your losses and let your profits run'. Most traders understand this rule, but performing on it often happens to be more difficult than expected. Greed and fear take turns to make losses from losing trades even larger (by keep adding to the position for example) and profits from profitable trades reduced by closing them too fast, out of fear of having to give back the winnings after. One easy guard against such conduct is picking a profit goal before you open the trade.
There are a number of different approachs to put in a profit target. For example, you could make it time dependent. Hold the position open for a pre-determined time, an hour, a day, a week or for however long you want to based on what type of trader you are, intra-day, short, medium, long-term before immediately closing it (assuming it's a winning trade that hasn't been stopped out already obviously).
These type of time targets have apparent limitations one of them being they don't take existing developments into consideration at all but for some traders they're the most effective solution. If you usually have the feeling you get out too soon or too late when working with price targets, then it can certainly be beneficial to just say: whatever will happen, in 24 hours I will close this position.
Another option, used by a lot of successful traders, is to utilize a trailing stop as exit strategy, or to look at price targets.
They may chose support/resistance points that lie within the trading choice of their trading horizon. Imagine that the EUR/USD is at 1,4750 and a long-term trader believes the euro is going to rise in the long run. He wouldn't mind holding the position open for six months or longer. Looking at the daily charts (1 candle = 1day) he notices that the EUR/USD has twice before touched the $1,6000 before falling back. He as a result puts his profit target at 1,60. He puts his stop a little beneath the low of the past 3 months, which is close to 1,4500. So he will risk 250 pips to acquire 1250. Whether or not that's a wise decision depends on the remainder of his trading system.
If he is correct 20 percent of the time, it would cost him 1000 pips typically to obtain 1250, for a profit of 50 pips per trade. That's not very much for a long term trader, but if he sees one such trade at least one time a week and opens at least 1 Standard Contract (1 pip = $10) for each trade once the oldest trade is six months old and would usually have reached its target he would earn $2,000 a month. That's definitely not enough to purchase a new Ferrari each year, but a used Beamer is nice too.
Scaling Exit Points
Many thriving traders ‘grow' in and out of their positions. They do not open the whole position at the same time, but start with only 1/3 position for instance. The idea is that they would like their hypothesis about price development to demonstrate itself first, which is why they restrict their risk to 1/3 of the total position. Should the price keep on to move in their direction, they will open another third, accompanied by another third.
On the other hand, you can also grow out of your position, using something known as scaling exit points. With scaling exit points, positions are closed down separately and have distinct price targets. Below is a good example of this. This is certainly not the only way to use scaling exit points, it's simply an illustration of how you could use them to your benefit.
Example of scaling exit points
Trader X is an intra-day trader. He puts on two, long EUR/USD positions at $1,4750. He places his stops at $1,4728.
Position I – Entry $1,4750 – Target $1,4780
Position II – Entry $1,4750 – Target $1,4820
At $1,4760 he puts on another long position, because he presently owns more evidence that the price is going into his direction.
Position III – Entry $1,4760 – Target $1,4900
When the price gets to $1,4780, position I is closed down and trader X moves up the stop loss of position II to its break-even level, at $1,4750.
At $1,4800 he shifts the stop loss of position II and III to $1,4775.
At $1,4820 the target of Position II is attained and the position is closed.
At $1,4900 the third position is also closed down.
If the trade goes properly, trader X could cash some nice profits. Furthermore, he can secure part of those profits early on, by moving up his stop losses, without truly closing the positions. So if the move remains his profits will still accumulate. These various exit points are feasible because trader X has divided his position in three parts. He can as a result realize profits for parts of his position without having to be out of the trade entirely.
How scaling exit points would best help your trading style is something you can learn by experimenting with them a bit and spending some time considering it.