An important question for traders to consider is: "What happens if the trade goes against you?" You can prepare for this possibility by determining an exit target (also called a stop-loss target) before entering a trade. The stop-loss target is the price at which you’ll close out the position and simply take the loss.
While most traders understand the importance of having a plan in case a trade goes against them, fewer consistently prepare for winning trades. Like experienced traders, you can develop the practice of setting a profit exit, the price at which you’ll close out the trade and take profits, locking in your gains.
Determining exits with points
Depending on your objectives and strategy, you can take numerous approaches to determine target prices for both opening and closing positions.
In the example below, we use a technical analysis concept—support and resistance—to identify target prices. Support is the level where buying interest appears strong enough to overcome selling pressure. Resistance is the level where selling pressure appears strong enough to overcome buying pressure. We’ve determined that we want to open a long position for XYZ at $30.
Based on the resistance level within this trading range, we’ve forecasted a three-point gain, so we add three points, or $3, to the $30 entry price and set the profit target for this position at $33.
Next we set the stop-loss target. If the price goes much below $30, it will have “broken through” support—that’s generally considered a bearish signal and a reason to exit the position. With this in mind, we’ve determined that we don’t want to risk more than one point on the trade. When we subtract one point, or $1, from the $30 entry price, it leaves us with a stop-loss target of $29. It is valuable for each position you trade to have a current opinion of the risk/reward. You may want to adjust your target price up as stocks rally, but be cautious about violating your risk target price down.
Determining exits with percentages
If we want to use percentages instead of points to determine our targets, we add or subtract the percentage amount from the entry price. Let’s say we’ve chosen 10% for our profit target and 3% for our risk.
We calculate our profit exit by adding 10% of $30, or $3.00, to our $30 entry price for a profit target of $33.00. Likewise, we then subtract 3% of $30, or $.90, from the $30 entry price for a stop-loss target of $29.10. This calculation aligns with the support level of the stock, so technical analysis has confirmed our exit plan.
Consider using support and resistance lines to help you identify potential profit and stop-loss prices. You can’t control the market, but by taking a little extra time to analyze its movements, you can develop your own strategies to decide exactly when you want to get in and when you want to get out.