When to exit

Exits

Ashwani Gujral | Excerpt from How to Make Money Trading Derivatives by Ashwani Gujral.

The exit aspect of trading is probably more important than even entries. I like to treat exits as a separate part of technical analysis, called trade management. I believe a good entry into a trade is only 25% of the job, albeit a very important one. The part that makes money is money management. The skill of keeping a position through the gyrations of the market is as difficult to achieve, of not more , as are sound entries. Most successful traders make most of their money from very few trades. So once you are in the right trade, its critical to manage it well in order to get the maximum profit out of it. You can be assured that the market would try to shake you out more often than you think.

Rules for Good Exits

You need to decide the exit before entering a trade

Once you see an entry set-up, you must have two scenarios ready:

1. How do you exit if the trade moves against you; this is done with a stop loss.
2. How do you decide on an exit if the trade moves in your direction. This is done with the help of chart patterns and certain back-of-the-envelop calculations of various patterns. In my experience, I have found that these patterns are good approximations of the minimum objective. So that gives you the initial estimate of how far you are going to hold the trade. This includes locating targets on intra-day as well as daily targets.
   

Trading Methodology: All rallies pull back at some point, and then the rally resumes again. On average, a pullback is about 50% not only of the previous move but also the subsequent move. This rule works broadly even in a bear market. The important thing here is to use finesse. Targets do not mean that a trader needs to blindly exit his position at that point. Rather, he then needs to be a little cautious , lighten positions or tighten stops, etc. in order to protect his profits.

It is critical for traders to listen to the market, and if the market is not acting as they think it should, you need to book profits immediately and wait for the market's next move. If your stop loss is hit, its not as if you have been proved wrong or have lost something. It can sometimes be the signal for bigger profits. If you can listen to the markets, you don't need most of the fancy indicators around. The market drops enough hints about what it's going to do next. Market re-entry at higher price should not be seen as an admission of failure, but as a prudent decision to wait for the market to show its hand more fully.

Trailing Stop
Once in profit, I like to keep a trailing stop at one ATR (average true range) so that the daily gyrations of the market do not throw me out of a position that is working. A trailing stop is one which trails the price. Putting it very close to the prevailing price can throw you out of a trade which has some way to go.

Scaling Out of Positions
Another good idea , though not my favourite, is to scale out of positions as they go into profits. Scaling in and scaling out are common strategies used by many traders. These traders take a small position first and then keep building if the trade moves in their direction. Some traders I know sell a part of the position and thus essentially make a free position, or one that has a lower break-even. Their profits are generally lower than for traders who take an entire position together. I prefer the latter because I look at entry set-ups very carefully and make an entry in a low risk situation. I do not enter into trades till the market is set up perfectly. Traders who scale positions can be a little more relaxed about their set-ups and entries, since scaling involves both gradual building of positions and gradual profit taking. This way, scaling reduces a trader's initial risk