Approaches to exiting trades

I had a question the other day from a member of my trading systems course in regards to getting out of trades efficiently. This is a very important topic, and one that a great many traders struggle with, but one which often gets overlooked in many trading discussions. In this post I’ll share with you the three approaches I take in getting out of a position.

The first strategy for closing a trade is to exit when the reasoning behind the trade is no longer valid. That means if you are a trend trader in a long position, you would want to exit when it becomes clear that the up trend is no longer in place. If you are a range trader, you would exit upon realization that the range has been broken. And if you are a fundamental trader, you would look for indications that whatever got you in to the trade – be it earnings, economic growth, or whatever – has changed. In other words, the trading method you use to enter trades should dictate the approach you taking to getting out of them.

The second exit approach is to have a predefined target when you enter the trade. For a value stock trader, for example, that might be the price that represents approximate “fair value” for the stock. In technical terms that could be an important support or resistance area, the edge of a range, a Fibonacci projection or some other type of measured move, and things of that nature. This is not something you are likely to use in pure trend trading as the whole idea is to ride the trend, but it can be used by a trader who dips in and out of a trend, trying to catch the swings and reversals.

The final approach I take to exits is to have a spot, especially when the market is moving aggressively, that represents an extreme situation. By that I mean the market has gone too far, too fast and is not likely to be able to sustain that level (or at least will stall out). Having this kind of exit strategy helps to avoid those frustrating situations where a position becomes quite profitable very quickly, but then gives much of it back (if not all) shortly there after.

It is worth doing some testing of exit strategies. You can do that mechanically as you would testing entries. You just need to be able to isolate the performance of a system as it pertains to the exits. By that I mean if you were to test a few different exit approaches you would have to ensure that they all were based on the same entry points. Otherwise, the results might not be comparable.

You will note that nowhere above did I mention setting a predefined stoploss. I don’t use them. The stops I employ are used to exit me from trades when the criteria I used for being in the position is no longer valid (first approach mentioned above). They have nothing to do with limiting my loss to a certain amount. I control my risk in that regard through position sizing.

A good book on the subject of trade exits is Trade Your Way to Financial Freedom, by Van Tharp. This is a book I recommend on a lot of levels as its discussion of trading psychology and risk management are both excellent as well. For the sake of this discussion, though, it is one of the few that really focuses on the subject of trade exits in a meaningful fashion.

Struggling with support & resistance and knowing what the key market levels are? Check out the Price Distribution Analysis methods I use.

Bookmark to:

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