When to close a trade

Closing with confidence

Last week I talked about the kind of paralysis that stops us getting in to trades – and just how costly that can be.

This week, I’d like to move on to a different, but potentially even more costly problem – that of knowing when to get out of your trades.

When compared to closing a trade – opening one can seem dead easy.

Find something you fancy, decide how much you’re going to stake, and click “buy” or “sell”.

Great.

Now what?

When a plan comes together

Many, many traders open positions with the vaguest of exit plans – relying on little more than jittery fingers on their computer keyboard to make their closing decision for them.

However, I’d like to think that, as traders, we all have a well-thought-out exit plan for every trade.

An exit plan is as important for trades that go in your favour as it is for those that go against you. A solid plan will save your neck on a bad entry, and maximize your profits on a good trade.

It will prepare you for the ups, the downs … and the down-and-outs!

Let’s start off with the easiest (and happiest) of the three …

The ups

Great – you’ve opened your trade, it’s taken a little time to pan out, but now it’s riding high with a tasty profit on offer.

Remember – lovely as that profit looks in the open trades on your account – it doesn’t actually exist in real terms until you close the trade and take the money off the table.

Most traders will set themselves a price-based exit strategy (i.e. the market moves in their favour, until the instrument they’re holding hits the desired price level, then they close the trade out, taking that profit.)

These price-based profit targets are often determined by support or resistance levels on charts, or are set a specified distance from the entry point.

An important point to bear in mind when setting your profit target is the size of your trading fund and the kind of risks you’re prepared to take with that trading fund.

Let’s say that you’re trading with £5,000, and that you’re prepared to risk 2% of that on a trade. That means, that you’ll risk just £100 on any one trade. Now let’s say that your current open trade is showing £300 profit – that’s £300 sitting in the market at risk – that’s 6% of your original trading fund.

If the size of your profit is large in relation to the size of your trading fund – you should consider closing that position or, at least, protecting it by bringing your stop loss in tighter.

Well, that’s the nice bit out of the way – now we’ll address those times when our trades go against us …

The downs

Trading the financial markets can make us sweat – but feeling a little hot under the collar is not a reason to close out a trade.

Just as the markets don’t move in straight lines – so our trading positions can’t be expected to immediately float into sunny positive territory, without the odd foray into the negative.

So, how do we deal with those trades that are going against us – when do we sit tight? And when do we cut our losses?

In its simplest form: On a long trade, our exit point will generally be where a price breaks support; on a short trade, it’ll be where a price breaks resistance. (Allow sufficient space from these support/resistance levels to stop yourself getting stopped out by some market noise.)

Of course, trading isn’t quite as straightforward as that …

We all enter trades based on a “story” – be that a technical-based story, because of a great chart set-up; or a fundamentals-based story, because of some trading news; or a combination of the two. If that story changes, we need to reevaluate our trading position.

If the story is unchanged (and we’re still within our risk parameters – see below) then we need to sit tight.

And the down-and-outs

So, we’ve examined how to manage our trades in profit, and how to manage them in loss.

Now let’s take a look at what to do when it all goes horribly wrong!

Markets are, by their very nature, unpredictable. For that reason, there will be times when our trades get turned on their heads and we’ll lose money quickly.

That’s why – however carefully managed your exit strategy is – you should always have an automated stop loss in place, at the level where this trade could start to “hurt” your trading fund.

When this level is hit, the trade will be automatically closed – no dithering, no hovering over whether or not to “click the mouse” and take the loss.

Of course, when the markets have moved quickly, there’s also the issue of slippage to deal with, and if you’re trading very volatile, illiquid assets, like small-cap shares, this needs to be factored in.

By building these careful exit plans, we should never have nasty surprises in our trading – because we’ll have planned for them and worked them into our trading strategy.

I’m not suggested that you’ll be able to be completely impassive when your stop loss is hit – we’ll leave that to the trading robots – but you’ll find it easier to take the losses with the gains – and come out unscathed.

Happy trading!

Mark Rose

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