Traders often aim at buying low and selling high. So they focus on developing a good strategy for opening the transaction when the price of the underlying asset is low. But then, they forget to take care of the strategy for exiting the trade at the right time.
Having a strategy that will allow you to get out of the trade on time is no less important than knowing when to open a trading position. You should therefore think carefully about setting the stop-loss order, that will close the transaction automatically at the preset price level and take-profit that will close the position at the predetermined profit level.
Key Takeaways🔑
| →Having an exit strategy in trading is as essential as knowing when to open a trade. |
| →Stop-loss and take-profit orders can help automate your exit strategy and protect against significant losses. |
| →Understanding market volatility, risk tolerance, and the potential trend direction can aid in choosing the best exit strategy. |
Contents
The importance of having an exit strategy
The price in the markets is in constant movement. Sometimes, it changes rapidly after some news releases or special events. Sometimes, it is unpredictable. To protect your trading account against excessive loss, you should think about the exit strategy. It will help you to get out of the trade when the time is right.
Having such a strategy on hand is beneficial for one more reason. It minimises the effects of emotional trading. Every trader knows that emotions are not good advisors in the trading world. You may feel overconfident or anxious or too excited to be able to make the right decision about leaving the trade. Thus, following some rules you have established beforehand, might be very helpful.
Choosing the best strategy
There are a few factors you should take into consideration when deciding on the exit strategy. The first one is the volatility of the market. You will have to consider how often and how rapidly the price changes.
Then, to what degree you are convinced that the price will continue the previous direction. Base your assumptions on insightful analysis and not only on your feelings.
You should also think about risk. It is always involved in trading. But how big risk are you really ready to take? You may consider your risk-reward ratio which tells how big loss you can endure in comparison to the profit you believe to gain.
Exit strategies overview
Exiting on strength
The principle of this strategy is to exit the trade when there is a signal of strength in the direction of the trend that you have chosen to open a position. This works better for short term transactions and implies that you leave the trade before everybody else jump in and the price reversal will happen.
There is a risk you will exit too early with lower profit than you would gain if you had stayed with the position opened for a longer period of time.
You can use, among others, pivot targets and oscillator extremes to recognise trend strength.
Exiting on weakness
Here, you search for weakness in the trend or a correction. This strategy is good for long term transactions. The downside is that the trend may resume and you will exit with the lower gaining that you would obtain if you had stayed with your position opened.
Moving averages, analysis of double tops or bottoms or prior swing lows will help you to identify the weaknesses.
Stop loss and take profit target at the support and resistance levels
Support and resistance lines can help you to decide where to place a stop loss and take profit. You should look for a swing in the chart to a higher level and place a stop loss at several pips higher. Then, consider what is your risk to reward ratio. If it is, for example, 1:3 set a take profit at the level three times higher than stop loss.
For instance, if you have placed a stop loss 50 pips lower than your entry point, your take profit should be at 150 pips over the point you have entered the trade.
Moving average and a trailing stop loss
Use a moving average to set a trailing stop loss. When the price crosses the moving average from the bottom or the top, it tells you that the direction of the price is going to change and you might want to end your trade. So adjust your stop loss together with the moving average movement.
The same rule applies to the setting of the take profit. Decide on what your risk to reward ratio is and place the take profit accordingly.
A disadvantage of this strategy is that you have to observe the price and change the levels of stop loss and take profit.
Pros and Cons 📊
Pros 👍:
- An exit strategy minimizes the effects of emotional trading, fostering more rational decision-making.
- Stop-loss and take-profit orders can protect against severe losses and ensure profits are taken at optimal points.
- Applying an exit strategy can reduce trading stress, as you have predetermined points for closing positions.
Cons 👎:
- Over-reliance on exit strategies may lead to early exits, potentially missing out on further profits.
- Market fluctuations can trigger stop-loss orders, resulting in an early exit from a potentially profitable trade.
- Monitoring and adjusting exit strategies, particularly in volatile markets, can be time-consuming.
| Exit Strategy | Explanation |
|---|---|
| Exiting on Strength | Exiting the trade when there is a signal of strength in the direction of the trend. Mostly used for short-term transactions. |
| Exiting on Weakness | Exiting the trade when there is a signal of weakness in the trend. Mostly used for long-term transactions. |
| Stop Loss and Take Profit | Automatically close the position at a predetermined loss or profit level, often set at support and resistance levels. |
| Moving Average and Trailing Stop Loss | A strategy that adjusts stop loss along with the moving average, triggering an exit when the price crosses the moving average. |
Conclusion
It is very important that you develop the exit strategy for your trades. It will help you to limit losses and leave the trade with some profit. Risk is an indispensable part of trading, and you must be ready to take some losses. However, you can work on limiting them and on growing slowly the amount of money in your trading account.
I have presented a few exit strategies you can use for your trades at Olymp Trade. As always, I recommend you practice on the demo account which is free of charge and supplied with virtual cash. You can trade there for some time and find out which exit strategy works best for you.
Would you like to share your thoughts on different approaches to leaving the trades? Below, you will find the comments section which is a perfect place to do that! I would be glad to hear from you.
Best of luck and high profits!
FAQs 📝
- Q: Why is an exit strategy important in trading?
- A: An exit strategy allows traders to protect their trading account from substantial losses and aids in mitigating the effects of emotional trading.
- Q: What are some common types of exit strategies?
- A: Some common exit strategies include exiting on strength, exiting on weakness, and using stop-loss and take-profit orders. A moving average and trailing stop loss strategy can also be employed.
- Q: Can an exit strategy guarantee profits?
- A: While an exit strategy can help protect against significant losses and ensure that profits are taken at certain points, it cannot guarantee profits due to the inherent uncertainty of the markets.
- Q: Can using an exit strategy lead to missed opportunities?
- A: Yes, over-reliance on exit strategies may lead to early exits, potentially missing out on further profits if the market continues in your favour after exiting.
- Q: What factors should be considered when choosing an exit strategy?
- A: Factors to consider when choosing an exit strategy include market volatility, the direction of the trend, and your personal risk tolerance.