What is Your Exit Strategy?
Capital preservation should be the priority for all traders.
Even longer-term investors should incorporate some risk management elements into their plan.
No matter how good your analysis, you must respect the market, or it will force you to respect it! So respect the market as you do not ever want to go from stockholder to STUCKholder! Getting deep in the hole on any trade or investment costs you opportunity elsewhere, along with costing you your objectivity.
All of us are wrong from time to time in the market, but the best traders know how to limit the damage done when they are wrong.
This is why an exit strategy is so important.
We have to accept some level of loss on some of our trades.
However we must define this loss before entering the trade to give yourself the best chance of profiting over time by preventing big hits to your account.
There are two ways to achieve this, either set a level and get out of the position when you hit it, or set a stop loss.
I have found stop losses to be a double edged sword.
While they do take you out of a position at a predetermined point they also make you vulnerable to volatility, some of it random, some of it manufactured to take out your stops! This is especially true when market conditions are more volatile - when it gets volatile you often find the opening and closing prices are not far apart, but the intra-day prices fluctuate wildly.
For newer or traders that find the discipline of selling hard to master, then stop-losses will emulate the traits of good traders in taking you out of you losing positions.
Even if you have never been taught how to set stops or an approach to determining the level for your stops, choosing an arbitrary price to set your stop is better than not having one at all.
Over 80% of traders do not have an exit strategy, so simply by having one you are in the top 20%.
Deciding on stop loss levels will largely depend on a couple of factors; the individual stock and the overall market's behavior at that time.
To calculate my stop-loss level (whether an automatic or manual one) I like to use a multiple of the Average True Range (ATR).
The ATR takes into account how much the stock is moving over a given period.
A full explanation is too long for this article, but Google it and you will find a full description.
Depending on how long term the trade is, I use a multiple of between 3 and 5 times the ATR, taken away from my entry price for my initial stop loss level.
From here I will calculate the ATR daily and take it from the previous day's closing price.
If this level is higher than the previous stop loss level I move it up.
If it is lower I leave the stop loss level where it was.
This approach takes into account the movement in the market and the stock at the point of entry and gradually reduces your potential loss level.
Thus the point of entry is always your maximum loss level.
Add to this, today's commission rates are low enough that even if you are stopped out you can cheaply re-enter the position later if you desire.
Small losses are the key to long-term success, whether you are an investor or a trader.
Your exit strategy exists for the very purpose of limiting your losses and opportunity costs by preserving your capital.
If you do not have one, get one!
Even longer-term investors should incorporate some risk management elements into their plan.
No matter how good your analysis, you must respect the market, or it will force you to respect it! So respect the market as you do not ever want to go from stockholder to STUCKholder! Getting deep in the hole on any trade or investment costs you opportunity elsewhere, along with costing you your objectivity.
All of us are wrong from time to time in the market, but the best traders know how to limit the damage done when they are wrong.
This is why an exit strategy is so important.
We have to accept some level of loss on some of our trades.
However we must define this loss before entering the trade to give yourself the best chance of profiting over time by preventing big hits to your account.
There are two ways to achieve this, either set a level and get out of the position when you hit it, or set a stop loss.
I have found stop losses to be a double edged sword.
While they do take you out of a position at a predetermined point they also make you vulnerable to volatility, some of it random, some of it manufactured to take out your stops! This is especially true when market conditions are more volatile - when it gets volatile you often find the opening and closing prices are not far apart, but the intra-day prices fluctuate wildly.
For newer or traders that find the discipline of selling hard to master, then stop-losses will emulate the traits of good traders in taking you out of you losing positions.
Even if you have never been taught how to set stops or an approach to determining the level for your stops, choosing an arbitrary price to set your stop is better than not having one at all.
Over 80% of traders do not have an exit strategy, so simply by having one you are in the top 20%.
Deciding on stop loss levels will largely depend on a couple of factors; the individual stock and the overall market's behavior at that time.
To calculate my stop-loss level (whether an automatic or manual one) I like to use a multiple of the Average True Range (ATR).
The ATR takes into account how much the stock is moving over a given period.
A full explanation is too long for this article, but Google it and you will find a full description.
Depending on how long term the trade is, I use a multiple of between 3 and 5 times the ATR, taken away from my entry price for my initial stop loss level.
From here I will calculate the ATR daily and take it from the previous day's closing price.
If this level is higher than the previous stop loss level I move it up.
If it is lower I leave the stop loss level where it was.
This approach takes into account the movement in the market and the stock at the point of entry and gradually reduces your potential loss level.
Thus the point of entry is always your maximum loss level.
Add to this, today's commission rates are low enough that even if you are stopped out you can cheaply re-enter the position later if you desire.
Small losses are the key to long-term success, whether you are an investor or a trader.
Your exit strategy exists for the very purpose of limiting your losses and opportunity costs by preserving your capital.
If you do not have one, get one!