TRADETHINK ARTICLES

Why Exits Are More Important Than Entries

November 21, 2007

By Chris Morse

There are two basic decisions a trader will make during a trade.   

1. When to enter the trade.
2. When to exit the trade.

Most traders will have some type of system or set of indicators showing them when to enter a new position. For trend traders one will usually look for either a breakout or a pullback. Once the signal is set the trader will enter the market.

A Trade Does One of Two Things

Once a trade has been placed it will do one of two things. It will either move in your favor or it will move against you. If you are long you want the market to go up. If you are short you want the market to go down. Depending on whether or not the trade moves in one direction or the other will typically dictate what the trade will do next. Some traders will use plain old gut instinct (not recommended). Others will have a percentage based exit and or a profit target.

The entry is relatively the easy question to answer. Where do I get in? Human nature will tell the trader something different once they are in the trade. Most traders let human nature interfere with their trading emotions. If a trade goes up the trader will often want to take the profit very soon right away (people don't like to loss). If the trade moves against them they will hope for the trade just to come back and break even for them. The markets will typically do the opposite of the trader's emotions. A losing trade will usually keep moving against the trader until it is too late and the winning trade that was taken off the table too early will keep going up.
It makes sense that paying greater attention to your trade exit is more important than your trade entry. How can we accomplish paying more attention to the exit than the entry without human emotion taking complete control over our trade decisions? I like to have a good set of trading rules and criteria before even entering a trade.

Let Your Winners Run and Cut Your Loses Short.
Using an automated type of trading system can help to take away the emotion of where to set the all important entry and exit prices/stops. I follow Trade Think and Trade Think gives precise buy and sell signals for every trade. Once in a trade the system will immediately place a protective and trailing stop. There is no emotion or discretion involved. The protective stop is for security purposes just in case the trade moves against you right away and it is designed to keep loses as small as possible and to exit a loser as quickly as possible.
The trailing stop or exit is designed to tighten up and protect profits and at the same time allowing the trade to keep moving if it is still going in your favor. I have seen too many trades lately where the market just keeps on going up. You need a strategy for letting your winners run.
Market Movers
2007 has seen many great market trends in commodities markets. Here are a few among the big commodities moves this year.

* Crude Oil has moved up over 50% from just $60 a barrel in January to over $90 a barrel recently.

A system will give you the discipline to exit a market and bank profits. The system will then enter the trade again for a continued move.

* Wheat has moved from just over $5 a bushel in January to over $9 at its October highs.

Without a solid exit strategy it is almost impossible to take this much out of a wheat move.

* Gold had moved from over $600 an ounce in January to over $800 an ounce this year.



Here is a move for over 90 dollars. This shows why exits are so important.

The US Dollar has moved lower to under 76.

Without a good exit strategy would you really still be in this trade?

The Euro Currency is trading at 1.47 to the Dollar. The Euro was at 1.27 in January.



Would you have the discipline to stay in this trade?

These are just a few of the moves for 2007. Many traders were able to spot the trends and participate in some of these markets this year. Most traders that participated exited out of their trades way to early. They did not have the discipline or trading method to stick with their trades.
Had a trader followed a strategy like Trade Think that allows winners to run and get out of loses before it was too late they probably would have done better with their trades this year.

The Bottom Line
When you are in a trade it is impossible to know whether the trade is a winner or a loser until you exit the trade. This is why exits are so important. The exit is where you decide how much of a loss or how big of a winner you have. Being prepared to exit with precise money management and trailing stops will help you get the most out of your trades.

I cannot stress the importance of trade exits enough. So many inexperienced traders just like to shoot from the hip or place a profit target. A profit target would have exited almost all of the trades above way too soon. You really need a dynamic way of placing exits with trailing stops.

Don't Trade with Money You Can't Afford to Lose

About the Author

Chris Morse is the Developer of the TradeThink trading system. He has been involved in the development of trading strategies for nearly ten years. Mr. Morse developed a very robust system which is now in private use at one of the largest FCM's and has earned sizable returns for the last 3 years. Mr. Morse now focuses his time exclusively on developing and managing his systems.