Most traders spend all their energy and time trying to find better entry methods or experimenting with indicators that promise a more accurate trade entry signal. Usually these traders experience very inconsistent results and wonder why all their efforts and improved entry systems do not lead to better performance. Trade exits are a very important component of a trading strategy but most traders do not fully know how to correctly exit trades. In this article we explore the two available trade exit methods, we analyze the pros and cons and which one you should choose for your own trading.
The 2 Market Exit Strategy Categories
There are only two different categories of trade exits strategies. The first one uses a fixed take profit order: when entering a trade, the trader picks price levels for his stop loss and take profit order and then waits until price reaches either one of them. The other trade exit category does not use a fixed take profit order. Instead, the trader trails the stop loss order behind price along the way and only exits when the stop is hit during a retracement. An understanding of both exit strategy categories and when to use them is very important because it allows you to pick the one that suits your trading style and personality.
The fixed take profit category
This is probably the most commonly used exit strategy. It is ideal for beginning traders, traders who do not always have time to monitor their trades and who have difficulties with the emotional factor. But let’s take a closer look at the pros and cons.
Pros:
1 – You can determine the reward:risk ratio
Once you set your take profit and stop loss orders, you can easily calculate the reward:risk ratio of your trades. Knowing the reward:risk ratio can be important for numerous reasons and it also helps you stay out of trades that do not have a big enough upside potential.
2 -Limiting emotional decision making
Traders who use a fixed take profit order can reduce the impacts of emotional trading mistakes. Once you know the price level where you want to get out, you just wait for price to get there. Greed often makes traders hold trades beyond their initial take profit level because they want more – usually they have to give back profits for being too greedy. Or, traders who are too fearful sweat every tick and tend to close trades too early ahead of their profit target. A fixed target allows you to walk away after placing your order which can help you reduce emotional mistakes.
3 – Little trade management needed
Especially if you are not a full-time trader, your time is probably limited. Thus, using a fixed take profit order enables you to place your trade, set your orders and then go on with your life. You do not have to worry about what is happening with your trade if you do not watch them.
The disadvantages of the fixed profit strategy are the advantages of the open-profit strategy and, thus, we will not list them here individually.
The open (floating) profit category
This strategy is more advanced and it usually requires a bit more experience and a stable character. But once a trader has mastered the emotional aspect of trading, applying the open profit strategy can offer a variety of benefits.
Pros:
1- You can potentially generate large profits
Not using a fixed take profit order and just trailing the stop loss behind current price allows the trader to, potentially, catch large winners. It is impossible to predict how long a trending move will last and not using fixed profit targets enables you to stay in your profitable trades much longer.
2 – Open minded trading
Traders who use a hard take profit order act within a fixed and closed mindset. They have precisely defined boundaries for their trades. Traders who do not use a hard take profit order constantly have to evaluate the whole chart to see what is going on. They do not restrict their thinking to the question “Can price make it to my take profit order”, but they have to evaluate whether the overall trend will go on or not.
Cons:
At this point we want to highlight the cons of the open take profit system. This method is better suited for advanced traders for a number of reasons and it is essential to understand the downside to avoid problems and mistakes.
1 – Emotions are an important influencer
The open take profit strategy requires you to constantly trail your stop loss order behind current price. This can become a problem for novice traders who have a hard time dealing with emotions. If you trail your stop too soon and too close to current price, minor price retracements can easily take you out. On the other hand, if you can’t deal with retracements and keep widening your stop during a retracement, you risk giving back profits.
Thus, the open take profit strategy should be used by emotionally stable traders.
2 – Time and work required
The other con is the involvement this strategy requires. Depending on your stop-trailing approach you have to regularly monitor your trades and, if needed, adjust your stop loss and trail it behind current price. This can become a problem when you do not have access to your trading platform at all times and, therefore, cannot manage your trades.
Summing it up: Trial and error – find what works best for you
We do not think that any strategy is superior over the other. Both strategies have their advantages and disadvantages. But it is important to be aware of the different possibilities so that you can make an educated and well informed decision about how to design your trading strategy.
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There is a substantial risk of loss in futures trading. Past performance is not Indicative of future results.
The placement of contingent orders by you or broker, or trading advisor, such as a “stop-loss” or “stop-limit” order, will not necessarily limit your losses to the intended amounts, since market conditions may make it impossible to execute such orders
