Let us put a mic in your mind and see what exactly does it have to say after reading the heading of today’s topic!
“Well, right now I have invested in stocks and plan to invest actively for the next 10 years. Should I book profit when I reach a target and reinvest at a lower level? Or should I hold the shares for the entire 10-year period and buy more when the price falls?”
Too loud and too many questions! Let’s discuss exciting strategies from a broader angle. First, let’s understand why should you have an exit ‘STRATEGY’?
Very often, emotions get in the way of making good trading decisions.
Investors do plan exiting (90% definitely do), but then hesitate to follow when the right time comes to take action, thus the results turn devastating. That’s why it’s so important that you have a plan for getting out of an investment.
Before entering your trade, start by calculating risk and reward levels, then use those levels as a blueprint to exit the position at the best price, whether you’re profiting or taking a loss.
Market timing (which is still an underemphasized concept) is a good exit strategy when used effectively.Planning stop-loss in advance and applying scaling methods enables a tech-savvy edge, which means low human error and greater accuracy.
One can protect their profits and shield from losses.You should consider these questions before getting into a trade.
Let’s assume you are in the middle of your investment and somehow become ambiguous with taking the trade forward. How will you know when it’s time to get out?
Having an exit strategy planned well beforehand fills the contour of your trading. Irrespective of being an active or passive trader ‘Exit strategies’ are crucial. You can create an exit strategy on your own or opt for equity advisory services.
Ways to Build an Exit Strategy
- Resistance and Support
Get into a habit of staring at charts until you understand the crux. Two technical levels act as prime parameters of when to enter and exit a trade. Support is the level at which the probability of demand for security is assumed to be strong enough to stop security to fall in the future. Support occurs when the security recoils from a series of lows (prices).
Now that you get acquainted with support, I’m sure you must have guessed about Resistance.
Resistance is exactly the opposite of support. It happens when security rebounds from a series of highs. In this case, supply wins over demand and hence acts like a great brick wall obstructing the prices to go any further.
Remember, when security struggles to break through resistance, get ready to exit the trade and book your profits.
- Target Profit/Loss ratio
Many investors make the most use of the profit/loss ratio because of its simplicity. It makes sense that potential gains should be as large as possible and lower potential losses at best.
This ratio clarifies an image of a trading system’s performance. The higher the number, the better the system is at predicting future price movements
Many investing books suggest a minimum of a 2:1 or 3:1 profit/loss ratio.
One can also consider this in terms of percentages i.e. (10% profit/5% loss targets). You can also play with numbers in case you are aiming for a better ratio.
- Time exit strategy
It is simply the maximum amount of time you decide to stay with a particular portfolio. At the end of the time horizon (whatever an investor has decided), you exit.
- The ‘1% rule’
This is a generalized thumb rule for investors, which says, an investor should set their loss to a maximum of 1% loss of their net liquid worth.
E.g., If your savings are Rs 1,00,000, then you should not be willing to bear a loss of beyond Rs 1000. There is another way of exiting your investments, this time fully automated, by using orders.
- Market Order
This is the fastest way to exit your trade/investments. This order execution is guaranteed, but the prices are variable because it is placed on a real-time basis.
- Limit Order
This order sets the minimum price at which one is willing to sell an investment. This order is not guaranteed because your price limit may never be reached.
- Stop Loss Order
Allows an investor/trader to place the target price below the price which you have decided to sell. On a real-time basis, when the price hits your order it gets converted into a Market Order and you’ll trade at the next price possible.
Caution: Stop loss doesn’t need to protect you from sudden price drops, during gap downs, it’s a total failure.
- Stop Limit Order:
The only difference between Stop Loss and Stop Limit is that Stop Limit sends a limit order rather than a market order, while the actual execution. The stop Limit sets the lowest price one is willing to sell off. Here one gets an advantage of gaps.
Execution on limit orders is not guaranteed, so there is a chance the security may never reach the lower limit.
- Conditional Order:
Conditional Orders are also referred to as bracket orders. It’s like placing a ‘one cancels the other order’, which allows a trader/investor to have both a limit order and a stop loss open at the same time.
Condition Orders can also be used to set a bracket for entering into a trade. In that case, it functions based on ‘one triggers a one cancels the other order’.
If you’re not yet sure (placing such an exit order could be a bit challenging until practices with few trades) to place an actual order to plan your exit, at least consider setting a price trigger alert or making a note to document your strategy. Paper trading is best considered to practice your exit strategies.
Planning your exit is one of the most critical parts of due diligence on an investment. A sound exit strategy can help you minimize your risk, control your emotions and obviously reap maximum profits. If you think it is not your cup of tea, instead of doing it on your own and risking your capital, it is better to opt for equity advisory services.