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Trader Q&A: Developing Exit Strategies

Schwab’s Trading Services team shares several tactics to developing an exit strategy.

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[John] Well, there's a lot, Lou, but some of the most classical, technical systems use support and resistance, which we've talked about a little bit earlier today, which is basically just finding those areas where buyers have stepped in to buy when a stock's falling and sellers have stepped in to sell when a stock's rising. And using support and resistance and that you can add other technical indicators like average true range, which is a measure of the range of trading over the last X number of days and StreetSmart ads. We use a default of 14 trading days. We also have some great third party resources that can help you with where to put your stop, things like Recognia. Lou, I know you like Recognia quite a bit.

[Lou] Yes. So on a trading strategy, I'm a big fan of letting our profits run and cutting our losses short. One of the biggest mistakes we make are we sell something that's going up too quickly because we don't want it to turn into another losing position. When something goes down and we cross our fingers, close our eyes, and pretend the stock's not going down, and what we see at the end of the year are a lot of small gains and a couple of big losses that really wipe us out. So when you're trying to develop a trading strategy, I would encourage you to let your profits run.

You're looking for a profit of two, three, or four times the amount of risk you're willing to take, meaning where you're going to sell it if it goes down with a stop order. And like John alluded to, one way of doing that is using a third party tool called Recognia. Recognia will ask you, "Do you plan on holding this stock for two to six weeks, six weeks to nine months, or nine months plus?" And then based on that answer they'll actually tell you where you might consider putting an exit strategy if something goes against you.

[Randy] Yeah, just one final point I would make, and we've talked about this a little bit previously, which is that you don't have to buy in all at one time and you don't have to sell out all at one time. I'm a huge fan of scaling in and scaling out. So if you have a feeling, and it may be just a hunch or it may be based on some sort of analysis or research that you've done that a stock might be getting someplace close to a top. If you sell it all out, you'll end up doing like Lou said, which is you'll be getting out way before you should have and it'll continue to run. You don't have to sell it all out. Maybe you've got 1,000 shares.

You sell out just a couple hundred and you take a little bit of the profit off the table and then you hang onto the rest of it. If you overall scale in and scale out, you'll oftentimes find that you'll end up doing overall a whole lot better because you'll lower your basis when you're getting in and you'll ultimately end up getting out an overall net profit. So if you miss the top, it's okay. If you think you're getting somewhere close, take a little bit of those profits off the table.

Again, there's another old expression. You don’t go broke taking a profit, but I think you should qualify that with, "But don't take the entire profit all at one time. If you think there's even a possibility that it has more to go, then just take a little bit of those profits off the table."

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