What is a Stock Exit Strategy?
How do you know when it’s time to sell a stock? Seasoned investors will have a stock exit strategy ready, to ensure they’re making an informed, strategic sale. A stock exit strategy is a pre-planned set of conditions for exiting a position based on one’s investment goal.
A good exit strategy is far from arbitrary. It’s not solely about saying “I’ll exit the position when the share price reaches $X.” Instead, it’s about making an informed prediction about the behavior of a stock and setting clear criteria for selling it. This depends heavily on your investing strategy. If you’re a day trader or swing trader, you’ll have much narrower, specific criteria. If you’re a long-term or buy-and-hold investor, your exit strategy may be more generalized.
Here are some of the most important considerations to make when formulating an exit strategy, and what it means to exit a position with confidence.
Stock exit Strategy: Set a Target Price and Stop Loss
Trades are either “winning” or “losing” depending on whether you make money or lose money. The golden rule of any trade is to set a target price and a stop loss. The target price is the price at which you’ll exit the position at a profit; the stop loss will cap your losses if the trade doesn’t pan out.
For example, if you buy a stock at $50 with the intent on selling at $52, you want to make sure you’re not losing more than you’re willing to risk on the trade. You set a stop loss at $48. While the share price might fluctuate around $50, nothing will happen until it either hits your target price ($52) or falls to your stop loss price ($48).
No matter your position or investment strategy, it’s vital to establish a target price and a stop loss to protect yourself—and to keep your actions aligned with your thesis.
Consider Holding Period
Depending on your investing strategy, time could be either an asset or a liability. For day traders, it’s in their best interest to be in a position for as short a time as possible. For long-term investors, the longer the time horizon, the greater the opportunity for returns. Here’s a look at the time horizon for different trading styles and the risk associated with time:
- Day Trading: Minutes to hours, high risk
- Swing Trading: Hours to days, high risk
- Position Trading: Days to weeks, moderate risk
- Investments: Weeks to months, low risk
Your stock exit strategy will vary tremendously across these time horizons. For example, a day trader following a triangle pattern needs to exit their position as soon as the pattern breaks out. If they don’t, their losses could be catastrophic the further the stock price deviates from the hypothesis. Conversely, if a long-term investor sells a stock after a couple of bad months, they lock in their losses. And these are losses that could turn into significant gains over the coming years.
When formulating an exit strategy, look at the time horizon first. It’s the single most important factor in determining when and how to exit a position under ideal circumstances.
Types of Stock Exit Strategies
Every investor operates differently, and has their own standards for risk and reward. However, there are several tried-and-true exit strategies that govern when and how to exit a position. Here’s a look at some of the most common stock exit strategies and how they work.
- Exit on strength. This strategy involves exiting a high. Many investors choose to sell off a stock when it jumps above recent resistance levels, signaling strength.
- Exit on weakness. This strategy involves waiting for recent highs to retrace to a new support level. It allows investors to exit without urgency, while capitalizing on trends.
- Exit on support. Investors buy when a stock develops a strong support level, with the intent to ride upward price appreciation to a predetermined level.
- Exit on resistance. Investors buy when a stock retraces from a resistance level, then hold until the stock trends above the previous resistance, breaking out into growth.
- Moving average strategy. Traders enter a position, then follow the stock price relative to the daily moving average. As soon as the stock price crosses the moving average, exit.
- Volatility-based strategy. Investors use Average True Range (ATR) to calculate the volatility of their position, then exit when the price reaches a multiple of the ATR.
These strategies represent winning trades. Any losing trades will trigger the stop loss, which will protect the investor from accruing major losses.
Bear in mind that these are also only a small representation of different types of exit strategies. There are variations on these approaches and many other strategies investors use to validate trades and capitalize on positions.
Plan Your Exit With Confidence
Not every trade is a winner. The market is volatile and even the best-laid plans can go awry when a stock behaves erratically. It’s important to rely on your thesis and sound logic to time your exit from a position.
Are you still within your risk-reward level? Has your investment thesis changed? What risk do you run by staying in a position? Investors need to be critical in evaluating positions that fall outside the original exit strategy. Moreover, it’s important to realize that in some cases, it’s okay to take a loss. Selling a portfolio dud to offset capital gains, for example. Regardless of the situation, every stock exit strategy should include two imperatives: minimize risk and maximize profit.