You're in a winning trade, and now you need to figure out how you will exit the trade profitably. How you will exit a trade should be planned before you enter. Below we outline a number of different ways to exit a profitable trade; no matter which you choose to use, the goal is to strike a balance between letting profits run and not getting so greedy that you fail to realize the market is reversing on you.
Why Having an Exit Plan Is Important
Traders are told to “let their profits run,” but unfortunately that’s pretty vague advice. Let a profit run long enough and it will eventually turn back into a loss. Traders need a plan that allows them to let their profits run beyond what they typically lose on a losing trade, but also realize that the market will not move in their direction forever.
If you plan your profitable exits and find that over time they are bigger than your average loss, winning only 50% of your trades (or even less) can still make you a highly successful trader. Here are several methods to help you do it.
The trailing stop is probably the most well know profit extraction technique. In simplest terms, as the price moves in your favor, an exit order moves along with it, trailing the price by some set amount.
For example, suppose you buy a stock and place a $0.50 trailing stop. As the price moves up the trailing stop moves up with it, always staying $0.50 below the most recent high. It only moves higher though, never back down.
This is appealing because it allows the market to run in your favor indefinitely, but gets you out when the stock moves $0.50 against you (from the highest point). A trailing stop works the same way for a short position, except it will always trail the lowest price.
A trailing stop can be implemented in many ways. In an uptrend, a stop may be moved up to below recent lows. Thus, if the price creates a lower swing low you exit your trade. But if the price keeps making higher lows, then you keep moving the trailing stop up to lock in more and more profit. Please note that all chart examples were created using Freestockcharts.com.
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Certain indicators have a trailing stop built right in. For example, apply the Parabolic SAR for an idea on where to place your trailing stop. With each new price bar the indicator value will change, locking in a bit more profit. Other indicators that can be used for this function are Volatility Stops, Chandelier Exit, and even Bollinger Bands and Keltner Channels.
The trailing stop works best in strong trends, but if the trend is choppy it will often result in poorly timed exits. In Figure 1 and 2, the price did continue higher after the trade was closed, but it is impossible to squeeze every penny out of a trade. A trailing stop allows the market to run, but gets you out when there is a potential reversal underway.
Establishing a price target is a great way to establish your potential reward relative to risk. If you are risking $300 on a trade, but will make $900 if the price hits your target, your reward outweighs your risk 3:1. Also, if you set a stop loss and a price target, you can “walk away,” knowing that eventually one of the orders (stop or target) will get filled. This is advantageous to all traders, but especially those who lack time to constantly monitor their trades.
Price targets can be established for any trade using Fibonacci Extensions or support/resistance levels (discussed below). Commonly, price targets are used for trading chart patterns, with the target based on the size of the pattern.Price targets can be established for any trade using Fibonacci Extensions or support/resistance levels (discussed below). Commonly, price targets are used for trading chart patterns, with the target based on the size of the pattern.
The rule of thumb with any chart pattern is that you can add (for an upside breakout) the height of the pattern to breakout price to establish an approximate price targets. If the breakout is to the downside, subtract the height of the pattern from the breakout price.
If the price has been struggling to get higher than a certain point (resistance) you may opt to place a price target just below the resistance region. If you have a short position, you may opt to place a price target just above support.
In Figure 4, Citigroup © was moving in an uptrend, but then failed to significantly move higher, and began to range. Once the price showed a tendency to stall at the support and resistance areas, profit targets could have been placed near the resistance zone for long trades, and near the support zone for short trades.
The downside of using a fixed price target is that there is no leeway. The price could come just shy of the target, and reverse. To avoid this you may wish to monitor the price as it approaches your target; if it almost reaches the target and then starts to move against you, exit the trade.
Entry Criteria Disappears
If you’re in a profitable trade and the reason you were in the trade disappears, you have probable cause to get out.
Assume a stock is trending higher—making higher swing highs and higher swing lows—and so you enter a long position. If the price makes a lower swing high and lower swing low the trend could be over, so you would exit the trade.
If you use indicators, you may get into a trade because the indicator gave you positive signals. When the indicator “flips” and no longer confirms your trade, you can book your profit and look for other opportunities.
Figure 5 shows a scenario during a downtrend. Assume you are short because the trend is down, and/or an indicator is bearish.
The chart shows two potential profitable exits, although there are many others that could be used.
- When the downward trendline breaks you can exit the trade.
- When the MACD moves into positive territory (above zero) you could exit the trade, assuming you were short because the MACD was bearish prior.
- When the price makes a significant (slightly) higher low, and then begins to makes smaller higher highs and higher lows you could exit because there is evidence to suggest the trend is no longer down.
The downside to this method is that it requires some analysis, and can be very subjective. Just because an indicator “flips” or a trend is broken doesn’t necessarily mean it is the best time to exit a trade. It just tells you the reason you were in the trade is now gone.
The Bottom Line
There is no best way to exit a profitable trade. For some trades, one method will work well, but will fair worse on other trades. The key is to decide on a method and stick to it, potentially using some of these methods in conjunction with one another. By coming up with a game plan you will be able to see what works and what doesn’t, so you can make slight adjustments if needed. All these methods can help you “let your profits run,” but will get you out if the price moves too much against you. You’ll never squeeze every penny out of a trade, but utilizing the exit strategies outlined here will help you capture the bulk of a move.
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