When investing, whether trading or long term most people worry about the entry. Is the stock too high? Will it keep going lower? Will it be affected be the overall market conditions?
These are all valid questions and do play an integral part in any investment or trade. The one thing almost no one takes into account is where and how do I exit a trade, whether is a day trade, swing trade (few days or weeks), or a long term investment (3 months to multi years). I would argue that the exit is more important than the entry. Sure if you screw up and buy at the wrong time (shorting also, but that is another topic) you can be assured of a loss. However, more often than not, people are pretty good at entry of stocks, assuming they are not chasing hype and have been patient with their method. The place they mess up is the exit. They have no rules. Once you start making money, greed can take over. “I don’t want to sell too early, it might keep going,” or “The last time I sold when I made xx amount, I could have made 10 times that much.” Every entry, BEFORE even placed, should have an exit strategy.
Exit strategies can include the following:
1. Trailing Stop – A price below the peak gain price where you will take profits if the stock reverses and starts to sell.
2. Scale Out – Take the investment and scale out at fixed percent gain intervals. For example, and a great one for investing, if you own stock and it rises 25% up, sell 1/4 of the position. Once it rises to 50% gain on the balance, sell 1/2 of what you have left. You have now locked in a 25% gain on your original purchase. The balance should be at most locked at breakeven (meaning if it starts to sell, never let it go to a loss). On the balance, if the stock takes off strongly after a 50% gain, look to sell the balance and move on.
3. Forever Investment – If you have an investment that you think is a super deal longer term and you are lucky enough to get a 100% gain on it, immediately sell 1/2. Why? Because once you sell 1/2, you have done a superb thing. You have retrieved your original investment out of it, all the money, and still have 50% working. Even better, no matter what, even if the company goes bankrupt, you cannot lose. Ever. Take that 50% you have out, and try to find 2 other ideas that might do the same. The one thing to keep in mind here is there are only very very few Walmart, Home Depot’s, McDonalds etc. Even if you have locked in this part, be aware that tons of companies do superb for years, then the market changes and they bite the dust. It is super rare to find a new Proctor&Gamble or Microsoft.
4. Price Target – figure out from entry where you simply will just get out. For example you might purchase a stock at 12, but be very happy if it went to 15 in a month or 2. So that is your exit. Price targets are entirely dependent on expected hold time and should grow the longer you plan to hold the stock (within reason). The key to remember here is you have to take what the stock is capable of doing, not what you want the stock to do.
The goal is to know what kind of investment it is BEFORE you actually go into the stock. This way you know your exit strategy. One thing to pay close attention to is the forever investment. I would ALWAYS have a cutoff when wrong or more likely – at what point am I so right I should not let it go to a loss again?? Again, of the biggest mistakes people make is saying “Its a long term investment, I dont care.” Its your money, you should care. Even on those, you should have a short term price target IF you are so spot on you catch a big move. It does happen. To repeat, the general rule of thumb is to sell half if you gain 100% or close to it – always. It does not matter if this gain happens in 1 day or 2 years. At this point you have no risk at all. If you sell half, you have got all your original investment out, now you cannot lose. Dont use tax reasons to not sell it – I cannot even count the number of times I have seen people use that reason to not sell then the market takes care of that “tax problem” for you by taking away your gains. In addition, usually it is wise to have a real short term gain where you would just take the money and run. You buy a stock for long term at 10, then 2 days later its at 15. A 50% return in 2 days?? take that and run, at least 80% of it. Most of the time people are happy to get 20% in a YEAR. While you did not plan on a short term trade, you need to change your tune and take the windfall gains.
For other trades, which are shorter term, you should always be aware of pivot areas (most charting packages have a pivot formula if you cannot find them yourself – they are a V and /\ pattern). This is an area of possible resistance when it gets near – remember a downtrend is a series of lower highs and lower lows, an uptrend a series of higher highs and higher lows. Expect that to continue when the market appears to be trending. If you go long a downtrend trying to catch the low area, you can resonably expect that it would break a prior pivot low – so do not use that as your stop point. Most reversals happen AFTER a low is breached, but buyers step up and turn it higher. Occasionally it will make the higher low and turn up too. Just be aware of the market conditions so that you dont put a stop where it is likely to get hit.
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