In many ways, a good exit is as critical and difficult as achieving a good entry. For this reason, I have written this short guide for you.
Reading Time: 4 minutes Financial activity: Trading Knowledge level: Beginner
Summary
Why adopt an exit strategy?
Fixed money management exit
Trailing exits
Time-based exits
Volatility exits
Barrier exits
Technical signal exits
Conclusions
Why adopt an exit strategy?
There are two goals that a good exit strategy attempts
to achieve. The first one is to strictly control losses. The second goal of a
good exit strategy is to ride a profitable trade to full maturity. If a trade
is going favorably, it should be ridden as long as possible and for as much
profit as reasonably possible.
There are a wide variety of exit types to choose from
when developing an exit strategy and below we will see the most common.
Fixed money management exit
It’s the standard exit strategy and it’s based on a fixed
stop loss and a fixed target profit. So, if the market moves against the trade
more than a specified amount the position would be stopped with a loss, if the
market moves in favor of the trade of a specific amount, an exit would occur
with a known profit. Simple and basic!
There are many ways to decide where to place stops.
The simplest placement occurs by assessing the maximum amount of money that can
be risked on a given trade. Another way to set the stop is based on volatility.
A good way to set a money management stop is based on a price barrier, such as
a trendline or support/resistance level.
Trailing exits
A trailing exit is usually implemented with a
so-called trailing stop. The purpose behind this kind of exit is to lock in
some of the profits or to provide protection with a stop that is tighter than
the original money management stop, once the market begins to move in the
trade’s favor. Once it is in place, a good trailing stop can serve both as an
adaptive money management exit and as a profit-taking exit.
The stop can be set to trail, by a fixed dollar
amount, the highest (or lowest, if short) market price achieved during the
trade. Fixed barriers, like support/resistance levels, can also be used: the
stop would be jumped from barrier to barrier as the market moves in the trade’s
favor.
Time-based exits
Time-based exits involve getting out of the market on
a market order after having held a trade for a fixed period. The assumption is
that if the market has not, in the specified period, moved sufficiently to
trigger a profit target or some other kind of exit, then the trade is probably
dead; the trade should be closed out and we must wait for the next opportunity.
Volatility exits
A volatility exit depends on recognizing that the
level of risk is increasing due to rapidly rising market volatility. Under such
circumstances, it is prudent to close out positions. ATR indicator should be
used to monitor volatility.
Barrier exits
A barrier exit is taken when the market touches or
penetrates some barrier, such as a support or resistance, a trendline, or a
Fibonacci retracement level. Barrier exits are often the best exits: they
represent (theoretical) barriers beyond which the interpretation of market
action must be revised.
Technical signal exits
Signal exits occur when a system gives a technical signal
that is contrary to a currently held position and the position is closed for
that reason. The system generating the signal need not be the same one that
produced the signal that initiated the trade. For example, exits based on
pattern recognition, moving average crossovers, and divergences are technical signal
exits.
Conclusions
While waiting for a good opportunity to enter a trade,
there is no market risk, because if one opportunity to enter is missed another
will always come, when a trade is entered, failing to exit at an appropriate
moment can cost dearly! For this reason, always study carefully (through
numerous backtests) which exit strategy to adopt and how to best configure it.
A sincere wish of good work to all!
Written by F. GRAMOLA (*).
(*) Member of S.I.A.T., the Italian Society of Technical Analysis (member society of I.F.T.A. – International Federation of Technical Analysts).
Warning
We merely cite our personal opinions for educational purposes only.
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