Exit Strategies and Trader Confidence
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In the survey, a lot of you had questions so I thought I would answer those on the blog in the days and weeks ahead.
Confidence and Swing Trading Exit Strategies
Some of the questions had to do with overcoming fear after trying other strategies on penny stocks, options and other less reliable, volatile day trading strategies you mentioned. Also, we got a lot of questions about when is the best time to exit a stock while swing trading it.
I think gaining confidence and overcoming fear stems a lot from not being prepared and having a proven strategy on great stocks to begin with. Certain strategies I use such as the earnings eruptions and high tight flag strategy are well-tested and proven in the current market.
Not what was working twenty years ago or even five years ago when a given book was written, but what is working now.
After researching and back-testing hundreds of high tight flag and earnings breakouts on top stocks over the past few years, you begin to learn what the best performing trades have in common.
This goes a long way to build your confidence and to have a plan to exit the trade if it goes in your favor or not. All that research begins to point to an optimal stop-loss point and what to look for to get a higher win rate.
Just by doing all the research, compiling the data and staying on top of the current market goes a long way to build a winning trading plan and your confidence. Its a great start anyways.
Exit Strategies When Swing Trading
So when to sell or exit your swing trade comes down to classifying your trades to begin with and doing the required research to know how this type of stock reacts when a particular technical entry point is reached within a certain bullish technical pattern.
For instance, a large double bottom or flat base breakout on a top growth stock has a very different stop-loss point and exit strategy than an earnings eruptions trade.
The IBD system sets an exit point on these large consolidation patterns (like us, they look for double bottoms within longer-term uptrends) at about a 7% to 9% stop-loss below the technical entry point in the pattern.
You also have to have certain fundamental factors in place at the breakout point and see a lot of volume come in as its reaching the technical entry point.
If all the requirements in the strategy are not met, its more difficult to trade the stock with a lot of confidence. Some just jump in after the stock goes up because of what some call “FOMO” – the fear of missing out.
In a prior post I talked about a better option than just jumping in and flying by the seat of your pants. That usually does not work out well if you do that over say 10 trades.
If you miss a great technical entry point, the best opportunities will often offer a second great technical entry point in the days or weeks ahead.
After you have done the months of research and analysis (or have someone else do it for you), you can begin to see patterns and optimal stop-loss points with a particular strategy. With our high tight flag strategy, we noticed that nearly 90% were winners with a tight stop-loss if the stock and technical pattern met all the rules in the strategy.
In today’s market, we currently favor high, tight flag breakouts that meet these requirements. We know that if all the conditions are met in the strategy, we can use a much tighter stop with about a 2 to 1 risk/reward ratio and a very high win rate.
But doing all the back-testing and research gives us the confidence to trade these with large position sizes. Based on the uptrend leading into the consolidation, the technical and fundamental factors for the stock (like the float, volume, quality of the catalyst, industry, etc…), we know precisely where to place a stop and when to start taking profits.
Trading Exit Signals
Knowing when to exit a trade starts with understanding the type of trade and stock you are trading. Earnings breakouts are a lot different than trading large triangle patterns during a pullback to a consistent, long-term uptrend support.
With a high tight flag breakout or an earnings eruptions trade, the exit strategy is pretty straight-forward. These trades tend to last a few days to a couple weeks and tend to follow similar trading patterns after they reach their entry point.
How to Take Profits in Trading
With any strategy, you do not have to take it all off at once. Experienced traders will generally scale out of a trade at various exit points. With trading commissions as low as they are today, the cost is much lower to exit the trade in smaller pieces.
- For me, the first exit signal is just the percentage gain that a high percentage of these types of trades will reach.
High tight flags, that meet the rules in our high tight flag strategy, will move at least 7% to 10% while using a tight stop-loss with a very high win rate. (Only about 1 out of 5 high tight flags will meet all of my strategy rules at the technical entry point.)
This first exit signal can be acted upon automatically with a limit order. In fact, you could keep your trading extremely simple by just entering an OCO order (one cancels the other order). This is where you enter a limit order for your target sell price and stop-loss order all in one order with your online broker.
- Another exit signal is just a negative news release for the company followed up with some price confirmation. So the price confirms a new price direction by gapping lower or breaking below an opening range after the negative news.
Significant negative news for the company will generally affect the stock price. However, sometimes the news is already expected and the stock can actually move in the opposite direction because the outlook is suddenly better after getting past the bad news already baked into the stock price.
- Another exit signal for us is a large bearish candlestick pattern. Smaller ones tend to lead to smaller pullbacks and they are not as much of a concern on top stocks for longer-term swing trades.
- A fourth exit signal could be once the price takes out a prior “swing low” on a stock chart. This prior low is where the buyers stepped in before to push the stock higher.
If the price goes below this prior support, especially if it closes below it, its often a good exit point. A swing low is only formed once you have a multi-day downtrend followed by 2 higher highs.
- A fifth trading exit signal on stocks would be a rebound off of the 9 EMA, 20 EMA or 50 day moving average and a move into new highs. After moving into new highs, a move below a prior days low.
A lot of our trades get off to a strong start. After a first wave higher, they will often consolidate, rebound off of a key moving average, and then surge into new highs again.
Once that momentum fades, its usually a good time to pull the plug unless you are going for a much longer-term (multi-month) swing trade. However, at that point, the average percent gains per day usually falls off dramatically.
So your trading capital may be better off in another great trading opportunity that is just starting after reaching a good technical entry point.
Of course none of this applies to penny stocks or stocks under $20 in general. For those stocks, win rates are significantly lower and they tend to act much more erratically.
We only trade a very select few stocks under $20 that have both the strongest long-term trends and fundamental factors.
When You Enter a Stock Matters A lot When Trading
Gaining confidence also has a lot to do with getting in at the right time. Just today, we saw SPLK fall short of reaching the technical entry point in one of our favorite bottoming patterns.
Those who waited for the technical entry point we mentioned last night in the Daily Alert stayed out of a stock trending lower on a catalyst. SPLK may set up a great technical pattern a bit later and we will just keep in on our radar until then.
Knowing when to enter a stock makes knowing when to exit a trade easier. Generally, if we mistakenly jump in early and the price does not reach the entry point, we either sell immediately or wait for the next rebound intraday on a 5 minute chart.
How to Enter and Exit a Stock (an example)
The following video goes over recent stocks we traded that also appeared in our alert service this month.
The next step is to do the research and back-testing to develop your own strategy and then start using it on a simulator. This will help you build your confidence and fine-tune your strategy so the exit strategy will eventually become decisive and second nature.