Day Trading System - The Exit
Every day trading system must have a method for taking profits. In the previous page about STOPS, I brought up the old saying "cut your losses short and let your winners run". This page about EXITS has to do with the second half of that phrase..."let your winners run".
If you are a novice, I know you must be anxious to get over to the Day Trading Strategies page if you haven't already been there, but in reality what I'm going to show you here about exits and in the next section about position size, while maybe not as interesting as a day trading signal or setup, it's actually much more important. So hold up on the day trading signal and strategies section until you understand most of this information first.
Technically, the initial stop of a trade is an exit, but when writing about exits here, I'm referring to profit taking exits.
WHY IS THE EXIT SO IMPORTANT?
If you don't put a decent amount of consideration into your exits and how you go about taking profits, then your day trading system will never have a chance at making a positive expectancy. I haven't covered expectancy yet, but just understand for now, that if you don't create your day trading system so that it squeezes enough juice out of the trade, meaning letting your profits run enough, you'll run the risk of having a system with a negative expectancy..........and that ain't a good thing. Day trading stocks will just be a huge waste of money and time!
Exits are one of the major keys to developing a day trading system. You can't control whether a trade will be a winner or loser, but like the stop which enables you to control the maximum loss on a trade, the exit allows you to control how much profit can be made on a trade. Consistent day trading relies on letting those winners run.
Once your day trading signal has given you an entry and the trade has moved away from the stop, you've got to use an
exit strategy that allows the trade room to wiggle, but not get you out too soon. Otherwise, you may experience something very unpleasant.........a day trading system with both a poor win % AND a poor win/loss ratio. As you'll find out later, expectancy allows you to have one sub par variable, but not both. One of the variables has got to excel. The variable that I have worked on the most in the past is the win/loss ratio through exits. You increase the win/loss ratio by letting the winners run as far as you possibly can.
What do you think is going to happen if your day trading system has a win rate of only a mediocre 45% and your win/loss ratio is only 1.2 : 1. You're going to lose money! If you have no idea what I'm talking about here, don't worry, I'll go over all this number stuff in detail on the page called expectancy.
WHAT IS THE OBJECTIVE OF YOUR EXITS?
On the page about stops, I explained that having small, tight stops on a trade allowed you to have profit objectives that are decent multiples of your stop amount. The goal of the exit, is to utilize that small stop size and provide you with a profit, that is a reasonable amount of times higher than the stop. For example, you might target exits that are 2 x STOP, 3 x STOP or 4 x STOP.
The higher the multiple that you can get, the better. Over many trades, you want to see your average winning trade be higher than your average losing trade. Again, I'm not talking counter-trend trading here. That's not where my experience is. You might be able to get away with smaller winners than losers with counter-trend trading, since the win% tends to be over 50%. With the kind of day trading strategies that I have used, my objective has always been to milk the
trade and either let price run as far as it could or to set profit objectives that were more than the stop I had on the trade.
I can't emphasize this enough. In order to make money, your day trading system must somehow allow the winning trades to run, so that the average of your winning trades are sufficiently larger than the average of your losing trades. Later while learning about expectancy, you'll understand mathematically why this must be true, if using a day trading system that produces less winners than losers.
SO HOW DO YOU LET THE WINNERS RUN?
First I'll show you some simple day trading techniques, that I have used with success. You can also use some technical analysis that you learned from one of the day trading tutorials, such as trendlines. Then I'll show you some other methods that you might like to learn or even modify for your own use.
Keep in mind, there is no perfect exit method. Each exit method will work well, or not so well, in different situations. That's why I chose in my own trading, to diversify
and use different methods and even different profit objectives within a particular method. I'll explain below.
A very simple, but effective exit method that I personally like is the profit target. A profit target can be placed within your day trading platform, at a certain dollar amount away from the actual entry price you received from the day trading signal. One of the nice aspects of profit or price targets is that once the exit order is placed, you can walk away from the computer and do something else.........fix some lunch, workout, whatever. Seriously, not being in front of your computer all the time can be an advantage. It keeps you from messing around with the trade. And for a newbie, this is very important. You will continually be tempted to adjust or change something in the trade as price wiggles up or down, unless you have the emotions of a rock. Price is going to do what it's going to do. You have absolutely no control. As long as you have both a stop loss and a profit target in place, price is going to do one of three things before the end of the day, whether you are in front of the screen or not. Hit your stop,
hit your price target or near the close of the session, be somewhere in between. Your day trading platform could even automatically exit your position before the end of the session if your stop or profit target hasn't been hit.
Setting profit target exits within your day trading system allow you to set the targets at whatever multiple of your stop that your comfortable with. Again, allowing
you some control over the trade. Whether through backtesting or analyzing actual past trade history, you might find for example, that trying to achieve a profit target
through your day trading system of 7 x STOP is futile, because it occurs so infrequently. So, you might consider working exits that are maybe 2, 2.5, 3, or 4 x STOP levels.
That's something you can work out on your own. Obviously, the higher the multiple of the Stop, the lower the probability or chance of reaching the price target.
You will have more trades reach a 2 x STOP level, than you will a 4 x STOP level. Just another compromise in life.
In the next section on Position Size, you will learn why it's important to spread your account's money over more than just one stock, perhaps 10 or more stocks. So since position sizing will put you into more than one stock every day, here's another stock day trading tip: If you decide to use the profit target method for exits, consider using more than one profit target for the trades. In other words, if you make 6 entries in different stocks, you could place targets on 2 stocks @ 2 x STOP, 2 stocks @ 2.5 x STOP and 2 stocks @ 3 STOP or any other combination.
A good day trading platform can make what might seem complicated to you here, very easy and quick.
Another idea is to base the multiple of the stop on the relative size of the individual initial stop. If a particular trade allows for a very small stop, you might consider a relatively
large target, since the price distance would be easier to obtain.
In the chart below, AMZN breaks out and provides a nice entry. The red rectangle shows the 'Stop distance' from the Entry price to the Stop price. The green rectangles display the different multiples of the Stop distance. As you can see, had you placed a profit target at 5 x STOP on this trade, price would have driven all the way to the target before the closing bell. To bad they don't all work out like this one.
MON breaks out of a beautiful late afternoon Lateral, one of the chart patterns you learned about in the day trading tutorials. The trade setup would've given a nice stop placement. How many multiples of the stop could you of gotten here?
I think you can see that it doesn't take to many of these kinds of trades to wipe out lots of small losses. Design a day trading system that targets multiples of your stop loss and you'll be able to have less than 50% winners, maybe even only 35% winners and still make consistent day trading profits.
There is another profit target method that you might want to consider using. It's called Fibonacci Extension Levels. It's more complicated than the above profit objective technique, but you might like it, so check it out.
Before leaving this page, please understand that the two most important parts of any day trading system you'll create are the Exit and the Position Size of the trade. I'll cover Position Size next.