*Updated March 2023!
Making a profit in the financial markets requires a combination of multiple skills. Choosing when to open (enter) or close (exit) trades is one of a great many skills that a profitable trader should possess. Trade exits greatly determine whether or not you will make profits in the markets. It is best practice to exit a trade after you have made a considerable amount of profit. However, due to market volatility and a variety of reasons that can affect market prices, exiting trades at the right time requires good decision-making, which is also influenced by a myriad of factors. But first things first.
What is a Trade Exit?
A trader faces two outcomes when getting out of a trade: you could either take a profit or a loss. An exit strategy allows you to remove the guesswork from the equation. You don't have to worry about exiting a trade too early and missing out on profits. With an effective exit strategy, your trading experience is bound to improve.
Such exit strategies include:
A Trailing Stop
A trailing stop is a stop loss that moves up in tandem with the price of the stock. As an example, if a stock is trading at $10 and you place a trailing stop at $9, the stop will move up to $9.50 as the stock rises to $10.50.
Technical Indicators
Technical indicators are mathematical formulas for analyzing price data. There are thousands of technical indicators to choose from. The Relative Strength Index (RSI), the Stochastic Oscillator, and the MACD are three of the most popular technical indicators. Any of these technical indicators can be used as an exit strategy. When the indicator is above a certain level, you can buy, and when it is below a certain level, you can sell. Alternatively, you can buy when the indicator is above a certain level and place your stop loss at that level.
Other trading strategies can include the use of a moving average. A moving average is the average price of a financial instrument over a given time. A 50-day moving average, for example, takes the average price of a given asset over the last 50 days.
Factors to Consider When Choosing a Trade Exit Strategy
There is no one-size-fits-all answer to this question as the best trade exit strategy will vary depending on a trader's measure of risk and profit target. There are various ways to exit the markets and traders often do so with emotion, which is one of the top trading mistakes. These are some of the factors to consider the following factors when developing a trade exit strategy:
Trade goals
The first factor to consider when selecting a trade exit strategy is your trade goals. If you want to make a quick profit, you should think about a strategy that involves taking profits at predetermined levels. If you're going to hold the trade for a longer period, consider a strategy that involves holding the trade until it reaches a specific target price.
The risks involved in the trade
Another factor to consider when deciding on an exit strategy is the amount of risk involved. If you are at ease with the amount of risk involved in the trade, you are more likely to hold it for a more extended period, and if you are not comfortable with the level of risk in the trade, you may want to consider taking your profits at a predetermined level.
Personal preference of the trader
Personal preference is another important factor to consider when selecting a trade exit strategy. Some traders prefer to take profits at predetermined levels, whereas others prefer to hold the trade until it reaches a certain price target. It is ultimately up to the trader to decide how to exit a trade.
Market conditions
The trade exit strategy ought to be suitable given the state of the market. A trade exit strategy that depends on a breakout, for instance, might not work in a market that is consolidating.
The timeframe of the trade
A trade exit strategy needs to work within the trade's timetable. For instance, a deal that is anticipated to extend for several days or weeks would not be appropriate for a scalping approach.
Early Warning Signs That You Should Exit a Trade
Exiting a trade when it moves in an unwanted direction is common, especially among newbie traders. This can be done intuitively or technically through take-profit or stop-loss orders. A stop-loss order is not always the best way to exit a trade but it's how most traders often exit. Frequently, the market will move in the opposite direction and then reverse. If you have a stop loss order, you will be stopped out at a loss when the position you had taken is not favorable.
The following are some of the signs that may signal you to exit a trade:
The Market is Oversold
Oversold markets happen when prices have fallen too far and too quickly. This is often an indication that the market is about to turn. Oversold conditions can be measured in a variety of ways. The Relative Strength Index (RSI) is one popular method. The RSI is a technical indicator that assesses overbought or oversold conditions by measuring the magnitude of recent price changes.
The Market is Overbought
In the same way that the market can become oversold, it can also become overbought. When the market is overbought, it means that prices have risen far too quickly and far too far. This is frequently a sign that the market is about to back-pedal. There are several ways to measure overbought conditions, similar to the RSI. The Stochastic Oscillator is a popular method. The Stochastic Oscillator is a technical indicator that measures the close relative to the high-low range over a specified time whereby the market is at a Resistance Level. A resistance level is a price level that the market finds difficult to break through. Chart patterns such as double tops and triple tops are frequently used to identify resistance levels. When the market reaches a resistance level, it is frequently an indication that the market is about to reverse.
The Market is at a Support Level
A support level is a price level in which the market has difficulty falling below. Support levels are often identified by chart patterns such as double bottoms or triple bottoms. When the market is at a support level, it is commonly an indication that the market is about to repudiate. If the market has a relatively low value in comparison to the recent past, it is at a support level. A support level is one at which the market is expected to find support and rebound.
The Market is Making Lower Lows and Lower Highs
When the market makes lower lows and lower highs, it indicates that it is in a downtrend. A downtrend is a long-term downward movement. When the market is in a downtrend, it is often a sign that the market is about to counteract. This can guide your options as to whether you can exit a trade or not.
Why You Exit Trades Too Early
Trading offers a wide variety of money-making opportunities. However, people have often found themselves exiting trades too early and not making enough profit. You need extensive knowledge of the forex market to be able to close out your positions effectively. So why does this happen and what is the cause of it? Let’s find out:
Lack of Self-Confidence
If you lack confidence in yourself, you're less likely to make money in the financial markets. You’ll be too worried about losing your money to make good trades. A poor trading experience might also lead to a lack of confidence. After several losses, a trader is likely to start to question their trading choices. They are more likely to make mistakes and bad decisions such as an early exit from the trade.
Fear of Losing Money
Although it's crucial to keep in mind that losses are a part of trading, many people are terrified of losing money when they trade forex. Without experiencing some losses along the way, it is impossible to make money. To avoid giving up on your trading profession as a result of losses, it is essential to have a strategy in place.
Little Knowledge About Proper Trade Management
You have a lower chance of making money if you don't know how to manage your trades appropriately. You won't be able to make wise deals since you'll be too concerned about losing money. You won't be confident; instead, you'll be fearful, which will cause you to stop trading too soon. You have no idea how to properly manage their losses. With minimum trading knowledge, you might find yourself placing trades with no stop loss or exiting trades too early. As a result, you risk losing all your capital.
Lack of Patience
With a daily turnover of more than $5 trillion, the Forex market is one of the most liquid markets in the world. This means that there is always a large number of people trading in the market, making it difficult to predict. Therefore, when trading the forex market, it is critical to be patient to avoid mistakes such as, yes you guessed right; exiting trades too early.
No Discipline
Lack of discipline is one of the main reasons that contribute to the early exit of trades. You won't be able to make profits if you are too concerned about losing your money. When indulging in the financial markets, your mind should always be clear. Lacking discipline will cause you to close out your positions too early.
How to Prevent Early Trade Exits
Your objective should always be to stay in the market for as long as you can and hit your target profit. However, there are situations when you can run into a predicament that forces you to close your positions earlier than you had planned. Your persona or an outside element could be to blame for this. As a trader, you should have the technical know-how to mitigate these causes of early trade exiting. Here’s a carefully curated list of pointers on how to manage early trade exits;
Do not trade with leverage
Some brokers have high leverage that enables investors to manage a larger investment than they could otherwise afford. Leverage can boost an investor's potential earnings, but it can also increase their potential losses. Due to this, it is typically advised for investors to steer clear of trading using leverage.
Focus on your prime goal
You must know exactly what you want to achieve when trading. Before you begin trading, you must decide what you hope to accomplish. Once you have a specific objective, it will be simpler to keep motivated and stay focused on what you are doing.
Keep a Journal
You should keep a notebook with all the information about your transactions and your reflections on them. This will enable you to monitor your progress and determine what is and what is not working for you. It can also be useful for future reference when faced with similar scenarios.
Do not try to predict the market
The future course of the markets cannot be predicted with absolute certainty. Numerous elements, including world events, political shifts, and natural calamities, might influence market direction. Focus on diversifying your portfolio and long-term investing rather than trying to forecast the market.
Have a proper trading plan
Most likely, this advice is the most significant on the list. You should always have a plan before trading. Most individuals believe that the key to successful trading is identifying the ideal entry point. The most crucial thing is to know what you are doing and have a plan. Your entry point, your target profit, your stop-loss, and your risk-to-reward ratio should all be included in your trading plan.
Use a Risk Management Plan
A risk management plan is a formal document that describes how a company will address potential hazards as a risk management strategy. It should specify what might go wrong, how likely it is to occur, and the precautions that ought to be taken to lessen the risk. As new risks could develop over time, the risk management plan should be periodically examined and modified.
You should put a risk management strategy in place so that you'll be able to work in your field for a longer time if you do this. You will be able to determine how much you can afford to lose on each trade when you have a risk management strategy. You'll be able to work in your field for a longer time if you do this.
Stay Disciplined
Having a strategy for closing out a deal is crucial when you are engaged in one. Both your target profit level and your stop-loss level should be included in this plan. Once these levels are established, you must use self-control to maintain them. This can be challenging, especially if the transaction is not going your way and you are tempted to hang on in the hopes that things will change around. On the other hand, if you do not follow through with your plan, you are more likely to end up in the red over time.
You Should Always Have A Trade Exit Strategy
Having a trade exit strategy in every position that you open is one of the secrets to a profitable trading experience. Here are some reasons why you should always have a trading strategy in place
- Makes trading more systematic- A trader is more likely to adhere to their trading strategy and make less hasty decisions if they have a plan for how and when to close a position.
- Facilitates the removal of some of the uncertainty from trading- In the case where a trader knows when they will exit a trade, they can plan their entry point and trade management accordingly, rather than making decisions on the fly.
- Limits losses- Provided a trader has a plan for how and when to exit a trade, they can set a stop-loss level and exit if it is reached, rather than hoping the market will turn around.
- It can help to secure profits- If a trader knows when they will exit a trade, they can set a profit target and exit when it is met, rather than letting profits run and potentially losing them.
- Great for emotional control- When a trader has a strategy for exiting a trade, they are less likely to be swayed by emotions like greed or fear, which can lead to poor decision-making.
Final thoughts
The appropriate trading method, the right mindset, and the right belief systems are just as crucial as having a strong trading technique. The cornerstone of a successful trading approach is the idea that once a trade with a high probability is entered, 90% of the work is already done. Even though we all understand that we cannot control the market, many of us passionately attempt to do so. Having an exit strategy is the best way to protect yourself from the volatility of the forex market and to make profitable trades.
