Trade Exits Has To Be Part of Your Strategy
After a trader has learned to practice discipline when entering trades through the use of a trading plan and obeying his trading rules religiously when it comes to trading exits most traders have no idea what to do. Since most traders spent the majority of their time looking for trade entry methods, trade exits are usually always neglected and even though traders may be good at picking trade entries, not knowing how to deal with trade exits leads to inconsistent results and a variety of problems. Trade exits are arguably one of the more important aspects of trading since they determine the final outcome of a trade and the long-term success – or failure – of a trading system. The following two points describe the most common problems when it comes to trade exits:
- Executing a stop too late, hoping that the position will come back and let a loss get out of hand
- Taking profits too early without good reasons because of the fear of giving back profits
It is no exaggeration to say that the vast majority of trading failure can be attributed to one of these two mistakes and not knowing what to do about trade exits.
Set your orders when you enter a trade
The easiest and most effective way to deal with trade exits more effectively is by placing stop loss and take profit orders at the same time when you enter a trade. This has two benefits for traders:
1) Accurately determining costs and potential profits
Without a stop loss order in place, conducting risk and money management is impossible. If you do not define at which point to get out for a loss, you cannot define a position size for your trade. Some traders may argue that a mental stop gives them more flexibility, but just executing a mental stop a few points later than originally anticipated can result in significantly increased risk and if done repeatedly, reduce the expectancy of the trading system.
The same holds true for profit orders. If you do not know where to get out for a profit, you are shooting in the dark. Not having a profit in place means that you don’t know what to expect from your trade and you are, more or less, hoping for a good outcome – a very dangerous place to be in. It is comparable to a businessman acquiring a new business without knowing what to expect from it and whether or not he will be able to recoup his investment.
2) You are less likely to change them.
Psychology calls this the status-quo bias and it describes the fact that whenever confronted with a decision, humans usually prefer to stick with the default option and avoid making active changes. The reasoning behind this it that humans always try to avoid losses which subsequently leads to inaction. The pain and regret that arise from a loss that has been caused by one’s own actions is usually greater than the pain of a passively anticipated loss. An insurance company ran a test and they offered two insurance plans: an expensive one, covering all aspects and a cheap one with limited rights. In one state, that made the expensive plan of the default option and the cheaper version was the default option in another state. Interestingly, whatever the default option was, people most likely stayed with it and only an insignificant amount made an effort to change the plan. Another example would be parents not vaccinating their kids against the flu. Although the risk associated with the vaccination itself is smaller than the risk of the flu, not-doing anything and avoiding the regret that their decision about vaccinating has caused harm is often preferred overexposing the kid to the dangers of passive attracted sickness.
In investing, the status-quo bias can be used to help you overcome problems with trade exits. After you have set your stop loss and take profit order upon entering a trade, you are less likely to change your orders. The fear of regret that your own decisions may result in a larger loss or in reduced profits, will often keep you from interfering with your trades. Additionally, disabling the one-click trading option directly from your charts can also help you avoid some of the impulsive mistakes associated with trade exits.
Stop Loss Disclaimer: he 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.
Conclusion: Spend more time focusing on trade exits
We challenge you to look beyond trade entries and avoid the “treasure hunt” for the Holy Grail in trading which is often associated with a better entry methodology and a more accurate indicator. Instead, take a close look at your trade exits and evaluate how they impact your performance. You will be surprised that by following a more exit-oriented trading approach you will often be able to eliminate most of the mistakes that cost you money or keep you from realizing bigger winning trades.
If you always do what you’ve always done, you’ll always get what you’ve always got.”
– Henry Ford
There is a risk of loss in futures trading. Past performance is not indicative of future results.