Stock market commentary, analysis, insight and opinion of the RightLine Editors is available every Tuesday/Thursday evening & Saturday
afternoon. The following is excerpted from the:
September 17, 2020 - The RightLine Report
Notes From The Editor
A trader's exit strategy is much more important than their entry strategy. However, most traders spend the majority of their time working on stock selection and entry methods. With this in mind let's review the essential objectives and components of a profitable exit strategy:
An effective Exit Strategy accomplishes three objectives:
1) Minimizes any losses that may occur soon after entering a position
2) Maximizes your initial profits
3) Minimizes the amount of accumulated profit you give back
While there are dozens of different ways to reach these goals, an Exit Plan ultimately results in one specific number - the Exit Price.
Since price action results from the combined decisions of all buyers or sellers in a particular stock, we'll use a price action based Exit Plan as an example of how to accomplish the objectives.
1) Minimize Your Initial Losses - Deciding where to set the initial Exit Price can be a challenge. On the one hand you need to allow enough room for normal daily price fluctuations, yet not so much room that your losses are harmful if the trade goes against you early.
One simple way to arrive at this is to use the stock's ATR - Average True Range - for one bar of your chosen time frame. Once you know the amount of price movement that can reasonably be expected to occur, you can set your Exit Price beyond the ATR by a calculated amount.
This prevents normal price action from kicking you out of a trade, while a strong move against your position - and into your Exit Price - takes you out before serious damage can occur. Your initial Exit Price is called a "Stop," because it stops negative price action from injuring your trading capital.
2) Maximize Your Initial Profits - As price begins to move in your expected direction, the trade becomes less vulnerable to any negatives.
Price momentum then starts to influence the trade positively. Since you want to secure any profits as soon as possible, move your Exit Price - your Stop - in the same direction as the positive price move.
Move your Stop by exactly the same amount as the move itself.
For instance, if price moves favorably by $1.25, move your Exit Price in the same direction by $1.25. As you probably know, this procedure is called "trailing a Stop." Continue to move the Exit Price - the Trailing Stop - in the direction of the winning trade.
Do this on a regular basis that is related to your chosen time frame.
Intra-day traders using 30-minute bars will do it every half-hour.
Daily traders will move their Trailing Stops once a day - usually after the normal market session ends. Longer time frames require less frequent adjustments.
3) Minimize The Amount Of Profit You Give Back - One way to accomplish this goal is to include an element to your Exit Strategy that reduces the amount you are willing to risk once you reach a certain amount of profit.
You can do this by setting a profit goal. Once that goal is reached, move your Trailing Stop 25% to 50% closer to the current price than your normal "trailing" amount. Although this increases the likelihood that the Stop will be triggered, it allows for sudden positive moves while limiting the amount of profit you ultimately give back.
Below is a chart example of an Exit Strategy. It may appear a bit busy at first glance, so just follow the red numbers. You will quickly understand how it works.
This Exit Strategy example uses price action as measured by the Average True Range. You can develop exit plans based on other concepts too.
For instance, you might use a specific profit target taken at a certain percentage of gains, or changes in volatility. The list of possible Exit methods is long.
Placing Stops on all positions forces traders to plan ahead. This means deciding in advance exactly the amount of loss to take if the trade doesn't turn out as intended. Most traders spend the majority of their time focusing on "when to get in." However, at least twice as much attention should be placed on "when to get out."
Bottom Line ... "Always know when to get out before you get in."
Thomas Sutton, Editor
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