Investors harness many strategies to decide when to enter a trade, when to exit, and how to respond when market movements do not go their way.
There are multiple techniques available, but a few essential rules can help you understand how to initiate an entry order, choose the right exit strategy and decide when to forgo your original plan to take advantage of favourable trading conditions.
Entering A Trade
Like every aspect of trading, timing is essential, and you should follow the fundamentals regardless of the type of trade you are entering.
The first step is to follow trends to determine the likely movements of your selected investment instrument, but the trick is to try and get in before a trend has moved beyond its peak and is headed toward a reversal.
Experienced traders use breakouts and pullbacks as an alternative. A breakout indicates that a market has moved away from a previous resistance level and has the potential to gain momentum.
To do so, you can start by:
- Plotting trend lines between technical analysis indicators, identifying the highest highs and lowest lows.
- Outlining the major support or resistance levels a trend needs to surpass to be viable – and plot where that trend might end up on your chart.
- Looking for a possible pullback, where a trending market comes up against resistance and quickly begins to fall back.
Trading a breakout involves looking for where the short-term movements course-correct to the longer-term trajectory, so you must watch for the moment when the market breaks through support or resistance levels.
Stop entry and limit entry orders
Automated entry orders can mitigate the risk of missing out on the ideal point to enter a trade and avoid delays because of decision paralysis.
Rather than trying to keep continual oversight of the market for pullbacks and subsequent breakouts, traders can place entry orders just underneath the identified support or resistance level, immediately opening a trade if the circumstances are right.
Before deciding on an entry order, review your trading plan and verify that it complies with your wider trading strategy.
Choosing trade entry timeframes
Traders can select multiple timeframes to verify the likelihood of a trend producing a profitable trade instead of using one defined timeframe that might not reflect the bigger picture.
For example, if you are looking for pullback opportunities on the FTSE 100 over a four-hour chart, you might see a pullback with the potential to turn into a breakout.
To confirm that movement, you could:
- Review a daily chart to analyse how long the uptrend has been in place.
- Look for support or resistance levels across the broader trend.
- Use a ten-minute chart to understand what is happening over a smaller period.
- See whether there is greater demand from buyers or sellers in the current trading period.
However you approach your timeframes and charting, it is important not to confuse your analysis with an overflow of charts to try to scout for opportunities.
Rather, you should concentrate on a base chart and use a couple of others to verify a viable movement or confirm whether your initial analysis is correct.
Exiting A Trade
Picking the right time to exit a trade and close your position can be even more crucial than planning to enter a trade because if you jump too soon, you could lose out on significant profits – or forgo them altogether if you hold on too long.
There are just as many exit strategies and entry approaches, so you must decide when to cut your losses, take your profit and run, or use a defined method to determine when you have maxed out the available gains.
Establishing risk vs reward
Traders need to determine the risk vs reward associated with any trade, which helps them assess the point at which they make enough profit to offset the potential risk.
If your risk vs reward ratio is 1:1, you need to make a projected £20 profit to justify a possible £20 loss. A 1:2 ratio means you require an estimated £40 yield to accept the same loss level.
There is always a trade-off in any market, because investments never guarantee a profit, nor can you quantify the outcomes with absolute certainty. Therefore, you need to know what success rate is available to take the associated risk.
Most seasoned traders look for orders with the potential for a success rate of at least 50 per cent, which means that some timing errors or misjudgements are unlikely to outweigh the profit made and end up with a loss.
The opposite can happen if you pitch for a high risk vs reward ratio. Conversely, if you have a low risk, the profits are likely low and less worth the effort and risk for a minimal gain.
Your preferred trading style will determine your preferred risk vs reward ratio, and you can adjust this if your trades aren’t producing the results you had hoped for – a 1:3 balance is usually a good place to start.
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Defining exit positions before entering a trade
Every trader should have a defined exit plan before they enter a trade, which means you know when to accept a loss without exacerbating it further and when to take a profit and avoid any downward movement eating into your gains.
Stop loss and take profit orders are tools that allow you to implement your exit order before you enter a position.
Choosing the right exit strategy
The most straightforward exit approach is to place your stop loss at a level where a trade has failed, falling just below support or resistance levels if you are trading based on a breakout strategy.
You can pick a stop loss limit by multiplying the distance between the entry and stop by your calculated risk vs reward ratio.
However, be conscious of the likely timeframes for the market to reach your target. You can use a range of tools to uncover insights into the strength of a predicted move, such as:
- Moving averages
- Average true range
- Volume indicators
Realistic time frames vary between traders, so that could be an hour for a day trader, a few minutes for a scalper, or weeks for swing traders.
Reasons to exit a trade early
Some circumstances may mean that you are better off bypassing your original planned exit position because you need not hold fire until you hit a stop-loss position if it is obvious that the trade has failed.
Viable drivers for early exits might include:
- Unanticipated events, such as the sudden departure of a CEO for a business you are trading stocks in or a surprise monetary policy announcement by a central bank. If something new invalidates your exit strategy, it’s better to exit the trade immediately rather than accept greater losses.
- Market stagnation can cause movements to slow down and indicate that you won’t hit your target in a reasonable time. Rather than changing your approach, you can exit when you have verified that the market is too sluggish and accept profit at the current level.
Another good indicator is the moving average. If there are crossovers between a moving average and exponential moving average, it may signal that the trend you rely on will end shortly, and the time to exit might be sooner than planned.
How To Enter And Exit A Trade FAQ
How do trade entries and exits work in day trading?
Day trading means you enter positions and close them within one trading period or might choose to trade if price movements adjust in your favour within the trading day.
Most traders decide to exit as soon as they identify a failed breakdown and will re-enter when that failure has reversed, and the underlying trend has resumed.
What is closing or exiting a trade?
Closing your trade or exiting a position means you terminate your investment or trade by selling the stock or asset.
How do you decide when the right time is to exit a stock?
Stock traders usually use fundamental and technical analysis to predict future market values. Therefore, it may be a good time to exit if another stock is available with favourable fundamentals.
How do forex traders calculate entry and exit points?
Experienced traders often place stop-loss orders when entering a trade, using technical analysis indicators to stipulate a point at which they want to close their position.
Stop-loss orders are a way to mitigate potential loss levels if the market moves against the desired trajectory.
Can a trader close a trade if the market is closed?
No, positions can only be closed when the market is open. If the market is shut due to a market break, holiday or weekend, the order is generated, but the trade will not close until the market is next open.
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