Exit Strategy

If the trade has moved in the desired direction there will come a time when the profit needs to be realized. How and when this is done is an extremely important aspect of your whole trading business.

As mentioned [earlier in trading styles], there are differences in the way a revenue trader and growth trader approach the market.

For one, a growth trader who is looking for capital appreciation is usually not going to be concerned with profit targets because they want to catch as much of a trend as possible. Their main concern is giving the trend enough room by employing quite wide trailing stops. Where the revenue trader may look to use trailing stops also, they would not be so liberal with the size of their stop, wanting to use tighter stops to take advantage of smaller trends and be spending less time in the market per trade.

But it doesn’t stop there. As a trader there is an important personal characteristic you need to be aware of and that is your need to be right and your need for consistency as opposed to the longer term outlook.

Many traders have an issue with being wrong. For many reasons they find themselves seeking the system that provides a better than 50:50 win to loss ratio at the expense of larger but more consistent profits. There is absolutely nothing wrong with this but it is imperative that you find this out early on before you go committing funds to the market.

And so if a trader feels they seek more consistency in their trading, and a desire to see fewer losses than wins, their focus needs to be on the exit strategy that will help them achieve this aim. 

Consistency in trading is simply having a consistent ability to produce profits in a specified time frame; for example, a profit at the end of each month.

For a growth trader who looks to his or her yearly profit, what happens each month has less bearing, but to someone looking for income, this has a large bearing on the strategy used.

Profit Targets

Profit targets are an ideal method (but not the only one) for a revenue trader. Profit targets are simply set once the trade is initiated. If you enter a trade and place a stop loss and also a profit target, where if one is reached the other is cancelled (know as an OCO – one cancels other order), only two things can happen; price moves against you, you have a loss, price moves for you, you have a profit. You don’t need to do anything else like trail a stop.

Where you place you profit target is important. If you decide to set a profit target that is exactly that same as your risk, i.e. a 1:1 reward to risk ratio (after costs), then what is left is for you to find an entry technique that provides a higher than 50:50 win to loss ratio; the higher the ratio the better.

The higher the profit target, and thus the higher the reward to risk ratio, the lower the win to loss ratio you need; however bear in mind you need to know if you are emotionally capable of trading a system that provides a lower win to loss ratio, even if you know the reward to risk ratio is high.

Setting a smaller reward to risk profit target is very dangerous. By setting such a ratio you are restricting your ability to make consistent profits because you now need to find a higher win to loss ratio.

To understand this we have created the following table:

What is very obvious here is that the higher the win to loss ratio you can achieve the lower the reward to risk ratio you can apply, which simply means a smaller profit target is needed. Finding a system that provides a 70:30 win to loss ratio with the wins providing twice the risk is obviously the best, but bear in mind that higher win to loss ratios are more difficult to achieve.

You can also see from this chart that win to loss ratios of less than 50:50 require larger reward to risk ratios and this is the very reason growth traders and long term trend traders use wide trailing stops as opposed to profit targets, so as to offer as much chance of getting high reward to risk trades which occur when the trader catches large and long lasting trends.

Trailing Stops

Two of the most common trailing stops are the ones we mentioned in the Initial Stop Loss section.

• Previous high/low trailing stop
• Volatility trailing stop

If you’re initial stop loss was to use a 3 x ATR (10) for example, you may wish to use this as your trailing stop.

Or, if you used 3 day isolation as a place to put your initial stop loss behind, you may want to trail your stop when new 3 day isolation occurs.

NEVER TRAIL A STOP UNLESS IT IS MOVING IN YOUR FAVOUR. IF YOU ARE LONG A TRAILING STOP MUST ALWAYS GO UP; IF YOU ARE SHORT A TRAILING STOP MUST ALWAYS GO DOWN. NEVER TRAIL A STOP SO THAT YOUR EXIT PRICE IS LESS FAVOURABLE THAN IT WAS BEFORE.

Breakout Stops

As mentioned before, breakouts are a system in themselves in that they can be used to enter and exit a trade. The Turtles made this famous with the use of a 55 day breakout to enter and a 20 day breakout to exit.

In our 4 T’s system along with a trailing stop, we use a 5 day break out. Simply put, if long and price makes a lower low than the last 5 days (and in the 4 T’s system we chose not to count inside and counter bars), we exit. If short and price makes a higher high than the last 5 days, we exit.

Trigger Stops

A trigger stop is simply the use of a trigger (see trigger module) to exit a position.

For example a moving average crossover would be an exit strategy.

An overbought stochastic or RSI would be an exit strategy. If you were long, an exit strategy might be when the stochastic reaches overbought or above 80.

Any one of the triggers mentioned in the triggers module could be used to exit a trade.

The use of such strategies depends a lot on your style of trading. A growth trader would be reluctant to use an overbought stochastic as an exit strategy because when a market is in a decent trend, the stochastic will more than likely spend a lot of its time in the overbought zone.

A revenue trader looking for consistency may find these sorts of exit strategies beneficial.

How To Exit The Trade

All of the exit strategies mentioned above can use an intraday exit, except for some trigger stops, like a moving average crossover for example.

In these cases, like we mention in the module ‘3 Trade – Trading an Event’, you’ll need to decide if you enter towards the close of the exit trigger bar or at the open the following bar, bearing in mind the possibilities of gapping; or you can use a trigger to signal the movement of your stop closer to the current price action such as below the low of the trigger bar if long, or above the high if short.

Move on to Step 4 - Module 2 > Trading System Builder Tool Kit: Trading Rules > Filters