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Stock Exit Strategy: When and How to Get Out of a Stock
Getting out of a trade is a core aspect of being a successful trader. Those who are not successful are those who get out too early of a winning trade and stay in a losing trade too long. So how do we manage when we get out of a trade?
One key component is managing fear and greed. Fear will cause you to get out too early and greed will cause you to stay in too long. Having your exit strategy in place before you even enter the trade helps take the emotion out of getting out. Being able to operate consistently allows you to put the odds in your favor.
In this Hub we will discuss three areas to help create more successful trading. The first one I will cover is not really part of the exit strategy, but a key for getting into your trade correctly.
Proper Position Sizing
Sizing your position is so important, yet most people don't take the time to calculate the right size of trade you should have at any give point. Realistically you cannot be right on every trade. You are going to have some losers so you need to make sure that the losers you do have don't take you out of the game. How do you accomplish this? You size your positions in a consistent manner.
First off you should limit your total position size, which would be different than the amount you are willing to risk on any given trade. If you size your positions at 20% of your account size then you can have 5 positions on at any given time. If you size your positions at 10% then you can have 10 positions on at any given time.
If you have an account with a $5,000 balance and you make the decision to size your position at 10% then any position that you have will not exceed $500. In this scenario if you are purchasing a $10 stock then you could purchase 50 shares. Let's say your next position is a $25 stock. In this case you cannot purchase more than 20 shares. You now have two identical trades even though the per share price is quit a bit differently.
If you have equally sized position as stated above then you can better control your wins and loses so that you keep a positive in your account even if you have a losing streak.
Even though your position size may be 10% or 20% you cannot be willing to risk this amount. Your risk should be much less. If you were to risk 10% on any given trade then you could only be wrong ten times before you were out of business. Your risk should only be 2% - 5%.
Risking 2% on a trade would allow you to be wrong 50 times before you are out of business. This is highly unlikely. Risking 5% would allow you to be wrong 20 times before you were out of business. By keeping your "risk per trade" low you increase you probability of being successful.
What can you make on the trade you are looking at? When are you going to get out. Knowing the answer to these questions before you get in can help you in becoming a more profitable trader.
If you are looking at two $10 stocks that, according to your trading style, look ripe for an increase. Both have strong support at $9.50 so you plan to exit the trade should the stock drop below $9.50. In other words you are willing to risk .50 cents on this trade.
You then look at these two stocks and one has major overhead resistance at $10.50 and the other has its next point of resistance at $12.00. Which of these are the better trades? Obviously, the second is better, but let's look at both for a moment so that we understand why.
As the price moves up the logical place for the stock to turn around and come back down is at points of resistance. Unless your are an investor (hold stocks for longer term) you don't want to hold the stock through the draw backs. So in my scenario above on the first stock I am looking at making .50 cents while on the second stock I have the potential of $2.00.
it's not hard to figure out that $2.00 per share is better than .50 cents a share. But the better way to look at this is that on the first position your risk reward ratio is even. We are willing to risk .50 cents in order to make .50 cents. On the second position we are willing to risk .50 cents in order to make $2 per share. Our reward is four times that of our risk.
We should always take trades where our reward is at least three times our risk. Targeting four to fives times our risk is even better.
Proper position sizing, risk management, and risk reward ratio will make you a profitable trader.
A Great Lesson in Holding a Position
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Trailing A Stop
The last thing in the world that you want to do is give back profits that you have made. The best way to do this is to have a trailing stop loss. A stop loss order is pretty much as it's name implies. It stops the loss! Having the right stop loss order is key. If you have it too close you will get out of a trade prematurely. If you have it too loose then you will have too large of looses should a position go against you.
In the photo of the stock chart that has been provided in this Hub shows us some key areas for support. Moving averages, trend lines, and horizontal support lines will all act as support. At the $9.25 area you see two areas of support. The trend line and if you look close you will see a moving average running closely to the trend line. Just below this you see a dashed horizontal line. This is another area of support. Placing a stop below this area will get you out of a trade should the stock start tanking.
As the stock moves up it will form new support areas. You can continually move your stop up the trend line as the stock moves higher, above a moving average that you are using, or above horizontal areas of support.
Knowing how you are going to trail your stock takes the emotion out of trading. You are not going to place your stop order where you "feel" it should go, but are going to keep it in areas that mechanically make sense. Remember the old saying, "What goes up must come down." Not stock goes up forever. You will get out of this trade, the only question is when. The stop loss allows you to get out at a logical instead of an emotional point.
A Must Read For Any Serious Trader
Using Stop Limit Orders
A stop limit order is where you are going to limit your profits. You are going to stop your trade. Looking at the chart that I've placed in this Hub maybe you only want to ride this stock up to the $10.25 area. You can place a Stop Limit order that would not trigger until your profit objective is met. Remember that you should have a Stop Loss order also. You want to make sure that if one order is triggered that the other order is canceled. Most brokers offer OCO orders, which is an One Cancel Other order. Your opposite order is automatically canceled with this type of order.
There is nothing wrong with taking profits. However, if you are always limiting your profits then you will never have the large gains. You need to ride the ups and downs in order to get the big gains. Take the time to read the link I've placed in this Hub, "How Hubpages Made Me $12,000.00."
Knowing where to get out and how to get out, whether it is stopping a loss or taking your profit is very important. Managing this takes some skill, but it is worth the effort.