Having an Exit Strategy in Place
This article will be a brief introduction as to why having an exit strategy in place is so important. More specifically, having one in place prior to entering any trades.
It's relatively easy to get started trading stocks online. Because of this, many people get started without any type of plan.
The potential rewards and the excitement can draw people in very easily.
One of the drawbacks of this is that many people will enter a trade for whatever reason, and then wait, and wait, without ever considering having an exit strategy in place.
If the stock begins to rise, excitement begins and things start going around in your head. Things such as "I picked a good one this time", or "That was easy, I bet this one is gonna keep going much higher".
The initial fact of having UN-realized gains makes most people draw their attention to the potential for additional possible gains. Then, there's the other potential side of the trade.
When a stock starts going against you and you start to have UN-realized losses. This is when people start to think that "it must be a fakeout or something, it'll go back up soon", or "I'm down too much money now, I can't sell here or I'll have a loss".
Both of these scenarios show that the things that can go through your mind can be heavily derived from your emotions. In most cases, these same emotions will cause you to come up with "excuses" to yourself, as to why you shouldn't exit your position.
As mentioned above, either you'll lose too much money or you'll miss out on additional gains. Both of these mindsets will keep you in trades for too long.
So what do you do? You learn about having an exit strategy in place. And you learn how to do this prior to entering the trade in the first place. Meaning, before entering a new position, know what reasons would cause you to close out the position and at what price level.
This will greatly improve most traders results because knowing when to sell, and doing so, is the most important part of a trade. After all, you cannot have any realized gains unless you sell and you cannot limit losses unless you sell.
Here's a quick example of not having a strict exit strategy in place: After a week of trading, you look back over your trades and see that you made 10 complete trades that you have closed out. Out of the 10 trades, you notice that you had 8 winning trades and 2 losing trades.
You say to yourself, "pretty darn good" and pat yourself on the back. After all, that's an 80% winning rate. That's great right? Who wouldn't want a winning rate like that?
You then look to see how much profit you made for the week and see that you LOST $118.00 after commissions. What? That's right, you LOST $118.00 for the week on 80% winning trades out of 10.
Looking further, here are your results for each trade, in order they were completed: -$572, +$104, +$74, +$104, -$32, +$22, +$34, +$20, +$34 and +$94.
From looking at these results, you can tell that there was no exit strategy in place prior to entering these trades (at least for the first trade). If there was an exit strategy in place, it was either wrong for this trader or it wasn't followed.
Allowing a large loss compared to the amount of gains for the winning trades has caused a lot of work making and following 10 trades for a loss for the week. If this trader keeps this up all year, they'll be out about $25,000. That's if things don't get worse and they can keep up the 80% win rate.
In addition, maybe better Position Sizing should be used and attention towards cutting losses short with a having an exit strategy in place should be made a top priority. As you can see in this example, having an 80% win rate does not guarantee you'll make profits in the end. Be sure to learn about Trading Expectancy and Being Right.
This is just one example of the importance of having an exit strategy in place. You may find yourself in a similar situation. Performing periodic reviews, either daily, weekly or monthly depending on your trading frequency, will allow you to uncover things like this that need to be addressed. Without doing any type of review, you'll find yourself without any money left in your account and wonder what happened.