Trade Exits: What’s Your Way Out?
If you’ve ever watched the popular UK TV show ‘Dragons Den’, or one of its international equivalents, you will know that the dragons — just like venture capitalists — don’t invest unless they have a good idea of how and when they will get the money back from their investment. They only enter an investment if they have an exit strategy.
Retail investors and spread bettors should also have an exit strategy for each of their positions, but many don’t have one. They think only about their entries, and not their exits.
Exit When “YOU” Want To
If you don’t have an exit strategy, then there is a good chance that you will exit eventually anyway, but this will be when one of your holdings goes bust, or when you “really need the money” and are forced to cash-in. Selling something when you have to is usually the worst time to sell anything; just ask anyone who has tried selling a house as a consequence of debt, divorce or death.
Excuse the “long trading” parlance that keeps things simple. It may be just as bad to buy something when you really have to; e.g. to cover a short.
By defining an exit strategy up-front you can turn the tables by exiting when you want to rather than when you have to. Best of all, by defining your exit at the time of entry you take the uncertainty and emotion out of exiting. When a price falls, you don’t worry about what to do because you decided when you would get out before you even went in.
Depending on your trading vehicle (regular share dealing or spread betting), your time-frame (day trading, swing trading, position trading, or investing), and your methodology (technical or fundamental) you might choose from a number of possible exit strategies including:
Stop-Loss: When you enter a position, you decide what percentage or points fall will trigger you to “cut your loss” before it gets any bigger.
Profit Target: You decide in advance to cash in your position and bank the cash when your position rises by a certain percentage or a certain number of points.
Fundamental Change: Having bought a stock with a Price-Earnings (P/E) ratio of 7, an investor decides in advance that he will sell his shares when the company P/E rises to 20.
There are many other possible exit strategies, like simply exiting if a stock position goes nowhere over a predetermined period of time. And the strategy of not exiting until a penny stock goes bust may be perfectly valid… providing it was a conscious decision and you kept your position size small on the death-or-glory punt.
Multiple Exit Strategies
You don’t even need to choose between the various exit strategies, because you can have more than one.
Most spread betting providers allow you to specify a stop-loss and a profit target for your newly-opened positions. So you might decide to exit when the price has fallen by 5% or when it has risen by 20%. You don’t need to stay glued to your trading screen because the spread betting company will execute your exit strategy when the time is right.
You might even choose to combine technical, fundamental, automated and manual exit strategies. How about this?
“I will exit my newly-opened position if it falls by 5% or rises by 20% or does nothing within a month or when the P/E rises to 20.”
It’s not a concrete suggestion for all of your trades, it’s just an example.
Who says you have to exit your entire position all at once? You might enter with a £5,000 investment, and take back only your initial investment (leaving the net profit to run) when your holding doubles to £10,000. You might enter a £2-per-point spread bet with a view to taking back £1-per-point at the top of the swing while retaining £1-per-point to run on; like I suggested in my article Getting Into The Swing, Part 3.
If you don’t have an exit strategy to exit when you want to, you will likely only ever exit when you have to, and that’s usually a bad thing. So, what’s your way out?
Tony Loton is a private trader, and author of the book “Stop Orders” published by Harriman House.