Exit Strategies That Lock in Profits And-Or Minimize Losses

There are three things that we must consider when developing an exit strategy.

1. How long are we planning on being in this trade? 2. How much risk are we willing to take? 3. At what price point do we want to exit?"

How long are we planning on being in this trade? The answer to this question depends on what type of trader you are. If you are in it for a longer term (for more than six months), then you should focus on the following:

A) Set profit targets to be hit in several months, which will lessen the amount of trades you make.

B) Develop trailing stop-loss points that allow for profits to be locked in every so often in order to limit the downside potential. Remember, the primary goal of any trade should be to preserve capital.

C) Take profits in increments over a period of time to reduce volatility while liquidating.

D) Allow for volatility so that you keep your trades to a minimum.

E) Create exit strategies based on fundamental factors geared towards the longer term. For example, let's say you love the business model of ISRG and you believe the company's growth potential to be enormous. In this case, you may want to hold the stock long term and create a price target based of future earnings growth. However, if you are in a trade for the short-term, you should not concern yourself with these things because they really do not matter on a short term basis. Too many short term traders try to trade on fundamentals and it just does not make sense to do that. Fundamentals only work in the event you want to invest in a company rather than just trade their stock.

F) Set near-term profit targets that execute at opportune times to maximize profits. Here are some common execution points:

- Pivot Points (A technical indicator derived by calculating the numerical average of a particular stocks high, low and closing prices. - Fibonacci/Gann levels - Trend line breaks.

The key is to learn a system that works for you and one that develops solid stop-loss points that immediately get rid of stocks that do not perform in the desired manner.

How much risk are we willing to take? Risk is an important factor when trading. When determining our risk level, we are determining how much we can afford to lose. This will determine the length of our trade and the type of stop-loss we should use. Those who want less risk tend to set tighter stops and those who assume more risk give the position more room to maneuver or work as they say.

It is also important to set your stop-loss points so that they are kept from being set off by normal market volatility. This can be done several ways. The beta indicator can give you a good idea of how volatile the stock is relative to the market in general, but these are good for longer term traders who can tolerate 10% losses. Short term traders cannot take such a loss so using the beta as a guide is rendered worthless. Example would be if the beta is within 0 and 2, then you will be safe with a stop-loss point at around 10-20% lower than where you bought the stock. However, if the stock has a beta upwards of 3, you might want to consider setting an even lower stop-loss, or finding an important level to rely on (such as a long term trend line or moving average). Again, all this depends on the type of trader you are and how much risk you are willing to impose.

Where do we want to get out? You may ask, why would we want to set a take-profit point or limit order where we sell when our stock is performing well? The answer is, ideally, we don't want to do something like this but there are times when it is in your best interest. Many people become irrationally attached to their positions and hold the stocks when the underlying fundamentals or technicals of the trade have changed. The only thing good about a limit sell order is the fact that it takes the emotion out of the trade. It either hits your sell limit order or it hits your stop loss point and you can go about your business after you enter your orders and not have to worry about how your position is performing while you are away. If you are going to trade in this manner, your exit point should be set at a critical price level such as price resistance, trend line resistance or other technical points on the chart such as certain Fibonacci levels.

Conclusion Exit strategies and other money management techniques can greatly enhance your trading by eliminating emotion and reducing risk. Before you enter a trade, consider the three questions listed above and set a point at which you will sell for a loss, and a possible (but not written in stone) point at which you will sell for a gain.

David Colletti Founder StockTradersHQ.com The Headquarters for serious traders.

Copyright © 2008 StockTradersHQ.com

This article is courtesy of David Colletti, a ten year veteran stock trader and founder of StockTradershq.com. Our staff of professional technical traders analyze 1,000's of potential stocks every day to provide you with a list of stock recommendations nightly with the greatest potential for explosive gains. These stock picks are traded with our real-time portfolio. Email alerts are sent to members for every entry and exit. Our subscription service provides all the resources, stock picks and tools an investor needs to make very profitable, consistent trades while maximizing gains and minimizing losses. StockTradersHQ.com offers a 21 day free trial with full member access.

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