The Exit is Just as Important as the Entry

03/05/2013 6:00 am EST

Focus: TRADING

A good trade entry without a solid exit strategy isn’t really a good plan, says Gabe Velazquez of Online Trading Academy, and you will more than likely lose money.

In trading and investing, most of the focus is placed on entering trades with very little regard as to when to exit or close these trades. How can I say this with certainty? Is it not a fact that most investors make money in bull markets and then give back the majority of their gains in the ensuing bear cycles that follow? Do you think that would happen repeatedly if they had an exit strategy in place? I think not.

Many traders don’t have a problem pulling the trigger when it’s time to enter the market, so much so that they typically buy when prices are elevated and then have to suffer when the market pulls back. They hold on in hopes that the uptrend resumes, and if they’re lucky, it does, helping them to bail out of their losing positions. If this is indeed the case, this means that many investors pay little attention to the price they pay when getting in. This is puzzling to me since buying low and selling high is the only way I know of to make money buying and selling anything.

So if traders don’t have any issues entering the market, why is it then, that when it comes to exiting their trades people have such a hard time. There are (in my humble opinion) several reasons for this. The first is simply a lack of planning. When a professional enters a trade, he knows precisely what conditions have to be in place to trigger an exit. Moreover, he doesn’t have to think about, or second guess those conditions when they occur, he simply acts.

The novice trader on the other hand, is driven by the “what ifs” of emotion and impulsive decisions. The thought process goes something like this: “What if I sell now and the market continues higher, I’ll miss out on bigger profits,” or, “What if I don’t take my profits now and the market goes lower.” And my personal favorite for avoiding losses, “if I never sell, then I’ll never lose”. Sometimes a novice trader is forced to exit simply to relieve the pain of a losing a trade. Another common exit used by the inexperienced trader is when a losing trade returns to the price point where he initially entered the trade. The trader is usually very eager to sell here as this will make him whole again. As you might imagine trading in this manner is not conducive to long-term success, and yet it continues until the losses mount and the trader simply leaves the markets in disgust. Alternatively, a trader can learn to adhere to specific exit strategies, which can help in harvesting profits on a consistent basis.

There are many exit strategies that can be deployed depending on one’s trading style and risk temperament. In class I spend a considerably amount of time on exit strategies because I understand that this is one of the areas where a new trader faces some of the biggest challenges.

Specifically, the basic exit would be using a supply and demand zone. Simply, if we buy in a demand zone, we can use the nearest supply zone as our profit target. Another technique some traders apply would be to use a moving average as a trail mechanism and exit trigger. Regardless of the technique, a trader must have an exit planned out BEFORE he enters the market. By doing so, he will reduce the emotional and impulsive behavior that comes from watching the profit and loss column fluctuate back and forth when in a trade. At the end of the day, a good entry without a solid exit strategy isn’t really a good plan after all.

By Gabe Velazquez, Instructor, Online Trading Academy

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