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Know when to exit a trade

You’re in a plane and the stewardess is going through the safety procedures. Any sensible person will make sure that they know where the exits are in case of difficulties. The same applies to a large building, a railway station or a motorway – you always need to know how you get out of any situation, especially one which could be life-threatening. If you have thousands of dollars riding on a trading situation, your life – and certainly your income and your aspirations – could well be under threat so the ability to exit with as little damage as possible becomes really important. If you only take the time to create an exit strategy, you will find yourself able to cut down losses and maximize the profits.

When it comes down to it, there are only two ways you can get out of a trade – either when you take a profit or make a loss – usually referred to as take-profit and stop-loss orders (which can be abbreviated to S/L and T/P.

With a stop-loss, you place an order with your broker of choice to start selling equities at a specific point or price. Once this key point is reached the stop-loss order is transformed into a market order to sell. There are three key characteristics of all stop loss orders: they come in above the current asking price for a buy and below the current bid price on a sell. Nasdaq stop-losses constitute a market order once the stock is quoted at the stop-loss price.AMEX and NYSE stop-losses enable you to have rights to the next sale on the market when the price trades at the stop price.

The stop-loss orders themselves can be categorized into three types: GTC (Good till cancelled) which holds until the execution happens or you make a manual cancellation. Then there is a day order which expires after one trading day and finally a trailing stop – this keeps a set distance from the current price, without ever moving downwards.

If we now look at the other side of the equation, when you are taking a profit, there is a similarity in that they are transformed into market orders to sell when a key point is reached. Bradly these kind of orders keep to the same rules. The difference is that there is no “trailing” point and the exit point is always set above the current marketing price rather than below it.

There are key questions that you have to ask yourself when you are developing an exit strategy. First of these is for what length of time you are planning to be in a trade. This will depend on whether you are a short, medium or long term trader.

The second question you need to ask is about the level of risk that you are prepared to take. If your financial situation is restricted your ability to sustain a loss will not be high and you must tailor your exit strategy accordingly.