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 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.
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 and price stops declining. “Resistance” is the level where selling pressure appears strong enough to overcome buying pressure and price stops advancing.
Determining exits using points
In this example 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, which is generally considered to be a bearish signal and might offer a good 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 estimate of the potential reward versus risk. You may want to adjust your target price up as the stock advances in price, but be cautious lowering your stop-loss target from its original level.
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 target by adding 10% of $30, or $3.00, to our $30 entry price to arrive at a profit target of $33.00. Likewise, we then subtract 3% of $30, or $0.90, 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.
We’ve used dollar and percentage values to illustrate setting targets in the above examples. However, you should carefully consider exit points based on your own trade strategy and trade plan.
Money management—or position sizing—and risk management are important topics for a trader to consider. Using support and resistance is just one way a trader can go about determining exit points in advance of actually putting on a trade. Remember, 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.