Trading Exit Strategies: How To Maximize Your Profits
Many traders focus on finding the best entry points or the best indicator for their strategy, but they neglect the importance of exiting a trade properly. Exiting a trade is a crucial element in each strategy that can make or break it's trading performance. Also exit signals can help traders avoid emotional decisions and follow a consistent plan.
Knowing the importance of exits, there are still many questions to answer:
How do you know when to close a trade?
What criteria should you use to exit a trade?
How can you optimize your exit timing?
Can I use more than one exit? if so which one to combine?
The best way to answer these questions, as always, is testing. In general, If you have a short-term, then profit target will work really well, because we are trading a short move, but if we are trading a long term trend-following strategy, having a profit target will limit our winnings, as we don't know how long the trend will continue. Like I mentioned earlier, the best way is to test.
In this blog, I will show you 9 unique trading exit strategies to exit a trade. Keep in mind there is no best exit strategy, but each exit will suit a different type of strategy, also each exit will result in a different equity curve for your strategy. We will pick a strategy with base performance, and then see how each exit method affect that strategy.
Here is out base strategy, it is a simple robust mean reversion strategy.
Market: SP500 emini futures
Session: Daily session (8:30 - 15:15)
Timeframe: Daily bars
History: Jan 2007 - Mar 2023
Direction: Long only
Entry signal: buy when RSI2 < 25
Exit signal: sell when RSI2 > 75
This strategy is immortalized on a tumbler on StatOasis Traders Apparel Store
Trade Exit #1: Opposite Signal
If you are going long when then price is above 50 day simple moving average then it make sense that you exit when the price falls below the 50 day simple moving average, because at that point your thesis for entering the trade falls apart.
This usually works well for short term strategies using oscillators or SMAs to enter. This is not true for using a short term pattern or indicator to fine tune an entry to a long term strategy.
Our base strategy uses this first type of exit which is the opposite signal of RSI2 < 25, notice that for oscillators you will need to go the opposite level and flip the operator, while for averages usually flipping the operator is enough to get the opposite signal like simple moving average.
Also keep in mind that the opposite level can be different as markets go down faster than they go up, so instead of RSI2 > 75, you can use 90 or 60 or any level in between. Each level will produce a different result.
Trade Exit #2: Stop Loss
One of the most common exits is a stop loss, Many traders use is a stop loss, which is a predefined price level where you close a trade if it goes against you. Stop losses are widely recommended as a way to protect your capital and avoid large losses.
However, as I often mention in my community you will find that stop losses almost always harm your strategy performance by reducing your profits and increasing your drawdown. Instead of relying on stop losses, you can use other techniques to manage your risk and limit your exposure.
The way I like to use Stop Loss is as a final safety net, which tells me that my entry logic is invalid, At the same time it will prevent my account from suffering huge losses or risk of ruin. So from that point of view, it is usually far from the entry point.
Below are several ways to implement a stop loss, with a fixed dollar amount, fixed percent amount, and fixed average true range amount respectively.
Trade Exit #3: Profit Target
Profit targets are another exit strategy that traders use to lock in their gains. A profit target is a predetermined price level where you close a trade if it goes in your favor. Profit targets can help you capture the most profitable part of a price movement and avoid giving back your profits. However, profit targets can also limit your upside potential and reduce the reward-risk ratio of your trades. Therefore, you need to choose your profit targets carefully and adjust them according to the market you are trading.
For example the average daily move of Russell 2000 emini futures is $2630, while the average dollar daily range of Canadian dollar emini futures is $517. A $2000 profit target on the Russell will most likely hit every time we enter a trade, while it will rarely hit on the Canadian dollar strategy using same time held.
Just like stop loss, profit target can be a fixed dollar amount, percent, or ATR value.
Trade Exit #4: Trailing Stop
A trailing stop is a type of stop loss but on the positive side as it moves with the price as the price goes in your favor. A trailing stop allows you to protect your profits while giving your trade some room to breathe. A trailing stop can be based on a fixed amount, a percentage, or a technical indicator. The advantage of a trailing stop is that it can help you capture larger price movements and exit at the optimal point. The disadvantage is that it can increase the frequency of stop outs and reduce the win rate of your trades.
Below is 25% trailing stop after $1000 activation
Trade Exit #5: Pattern
Using patterns to exit a trade is a method that relies on the recognition of certain formations on the price chart. Patterns can indicate the continuation or reversal of a trend, as well as the strength or weakness of a short term price movement. By using patterns to exit a trade, you can align your exit with the market structure and anticipate the likely direction of the price. Some examples of patterns that can be used to exit a trade are candlesticks patterns, pull backs, triangles, and double tops or bottoms.
Trade Exit #6: Parabolic Move
I learned this from my mentor Perry Kaufman , when volatility spikes, the market move is about to end abruptly. It requires to implement volatility measurement on each market or on index for it's constituents. Also it can implemented with simple measurement of abnormal move in the short term.
In the test below, I use higher opens as a measure for abnormal move short term.
Trade Exit #7: Time Exit
A simple way to exit a trade is to set a time limit, such as minutes, days, months, or a number of bars. This may sound too easy, but it works well. Many traders don’t use this exit method enough.
A time limit can also help you avoid big losses by limiting your exposure to unseen events as you don’t stay in the market for too long,
A time limit can also prevent you from overfitting your strategy. You don’t need to waste time on finding the perfect exit, because a simple time limit is good enough.
Trade Exit #8: Indicators
Indicators are tools that help traders analyze the price movements and trends of a market. Some examples of indicators are moving averages, oscillators, and trend lines. They can help identify short term trends and reversals, also they ca act as points to nullify a thesis for the trade for example a break below a trend line. Oscillators are specially useful as they can easily be tuned to the market gyrations on the short term.
Below exit using the 100 day momentum > 10 period average of the same momentum.
Trade Exit #9: Layering
I recommend layering multiple exit methods. This advance approach involves using a combination of the above different types to determine when to exit a position. By layering multiple exit methods, traders can increase their chances of making a profitable trade. While it works with long term trading systems, but I will discuss short terms trading system below. I call it Trade Box. For example, lets say we are trading a short term strategy, we can add a box around this trade.
Floor (stop loss), that will protect our capital when our trade thesis prove wrong.
Ceiling (profit target) that will cease the opportunity if the market make a big move and then retrace back.
Time (number of bars) which is useful if market is moving sideways and we are better off investing our capital in another trader.
Indicator or a Pattern to exit inside the box if logic is true.
Those four exits will make sure that the trade will end within a predefined parameters.
Average True Range in dollars can easily give us the floor and ceiling, while average number of bars in a trade can easily help in determining the time limit.
We can still add another exit which is an indicator, opposite signal, or a trailing stop.
The above is RSI2 classic strategy with Trade Box:
Floor is defined by 3.5 ATR stop loss which rarely hit
Ceiling is defined by $4000 profit target
Time stop is defined by 10 bar exit which rarely hit
Finally parabolic exit inside the box
To learn more and to download the code, join the amazing free community at https://go.statoasis.com/community
A video discussing the above exits can be viewed below: