Selling Shares for Profit or Just Selling Out, Part 2.

In the last article we discussed one of the biggest challenges trader face, which is knowing when to sell. In this edition, we will address the strategies you need to consider for exiting a trade.

If your intention is to trade blue chip stocks for the medium term, then setting a price target on a profitable trade is what I call financial suicide. Your job as a trader is to take the lowest possible risk each time you trade. So why would you consider exiting a profitable trade when you know with 100% certainty that the stock is going your way. Not only will you be taking smaller profits but you will most likely enter another trade that you won’t know will be profitable. If you are using trend following indicators such as trend lines and moving averages, let these tools do the work for you by telling you where to exit; do not second guess them by exiting too early.

Setting tight stop losses on blue chip shares is another area in which many traders fail as they exit too early. Remember you need to let a stock settle into a trend after entering, but if you set a stop loss of 5% not only is there very little room for the stock to move but you will decrease your profitability. The minimum you should set your stop loss at on these types of stocks is 10%, although depending on their volatility my preference is around 15%.

If you trade speculative stocks you need to use analysis tools that are very sensitive to market changes, but once again you should wait for confirmation rather than speculate on a move. Tools that work effectively on speculative stocks include Dow Theory, Swing Charts, Fast Moving averages, MACD’s and Stochastic’s to name a few. Your stop loss also need to be tight, but be careful not to make it too tight as you will get stopped out more often than you would like.

If you are an options trader, things will obviously be very different because you are trading a highly leveraged and fast moving market. Therefore your exit strategies will need to reflect this because even if you wait an hour at times to exit a position you can lose a huge chunk of your money. Once you enter an options position you are far better off picking a range in time or price as your exit signal rather than waiting for confirmation as you would with blue chip shares, simply because it could cost you lots of money.

For example, if I was trading Newscorp options I know (from back testing the stock and my trading plan) for the most part when I get an entry I am pretty safe holding onto the option for three days and that I should achieve a good price movement during that time. Therefore I would be looking to exit at the beginning or end of day three depending on how strong the market was at the time.

So where do you put a stop loss on an option? This is a pretty common question and one that I have heard lots of answers to. But the best one in my book is that if after entering the option it turns against you, you should exit. The reason for this is that in options if you get a trade wrong you will, for the most part, lose 50%; therefore you need to limit the loss as much as possible.

Futures are different again; although they are highly leveraged they are less volatile than options and have less of a spread in the price between buyers and sellers. Therefore you need to select rules and stop losses that are appropriate to trading this market.

No matter what market you decide to trade, the most important aspect to your success in the share market is to prove to yourself that your trading plan works by back testing it. Any deficiencies in your plan will dramatically increase your probability of losing. As traders you also need to be aware of your win/loss ratio (how many times you win against how many times you lose) and your profit/loss ratio (how much we win against how much we lose) as this indicator alerts you to whether or not you are profitable. Once you understand these figures you then need to work on improving them so that you can become more profitable.

In my experience the first place traders should be looking to increase these ratios is their trading plan and the exit strategies they use. In reality, however, most traders continue scanning the market for the next biggest and best trade in the hope of increasing their profitability, which as I have mentioned can be their greatest downfall. Remember, the elite in anything are just that because they spend more time fine tuning their skill level and practicing their techniques, not because they just happen to show up on the day.

Let me say, if you decide to heed the practicality of the information in these articles, you will become a very profitable trader. If, however, you decide to enter an investment without a good exit strategy then you are gambling. And unfortunately gamblers always lose. Consistently successful traders, on the other hand, are risk managers not gamblers.

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