This four-part series looks at the trade life cycle, from pre-trade research to liquidation of a position. The final installment looks at the exit process.
Editor’s note: The “On/Off Ramp” is a four-part guide to trade entry, exit, and what happens in between. Part 1 introduced the series and looked at the trade entry process, Part 2 looked at navigating the holding period, and Part 3 considered making adjustments to a position.
OK, you’ve set your objectives, initiated a position, perhaps traded around it or even added to it, and now you’ve decided it’s time to say goodbye. When is it time to close the trade? And how should you close it?
Actually, you may be able to answer those trade exit questions by looking at your trade entry objectives. In the first part of this series we looked at a hypothetical example that compared a list of trade objectives such as “a bullish technical signal, plus a strong earnings release, bolstered by a news item.” In this example there are three distinct, objective analyses—news analysis, technical analysis, and fundamental analysis—for initiating the position.
Because these were the reasons for entering a bullish trade, an absence of one or more of them might be reason enough to close the trade. Perhaps the next earnings report didn’t follow through on the previously reported strength, or maybe you’ve identified a resistance level or other potentially bearish technical signal. If the reason you got into the trade in the first place no longer exists, it might be time to liquidate, regardless of profit or loss. No one likes losing trades, but closing a losing trade can free up your capital and your mind to help you get ready for the next trade.
But sometimes the numbers are your objective, or at least, they may play a part in the decision process. For instance, let’s expand on the example from Part 3, where an XYZ 13-strike call option was purchased for $2. Some traders set percentage gain and loss objectives, such as a 100% gain versus a 50% loss, perhaps with transaction costs figured in as well. In dollars and cents, this would mean setting exit objectives at $4 and $1.
So now that you’ve identified the reason for closing your trade, how can you go about closing it? The thinkorswim® platform from TD Ameritrade can alert you when one of your exits points is at hand, and there are a number of ways to close the trade.
One way to exit the trade, using the above example, would be to enter an order to sell the XYZ 13 call option to close at $4. This could be a simple limit order. You could also enter this trade as a good ’til canceled (GTC) order, which means pretty much just what it says: the order is good either until it’s filled (up to six months from the date), or you cancel it. Making the trade a GTC order versus a regular day order means you won’t need to enter the trade each day until it’s filled.
You could also enter a trade that would sell the call option to close if it drops to a certain price, which, in our example, would be $1. This type of trade is called a “stop-loss” order. It’s important to note that entering a stop-loss order does not guarantee execution at or near the price. Once activated, the order competes with other incoming market orders.
You could even enter a limit order at $4 and a stop-loss order at $1 as an OCO order, which stands for “one cancels other.” Once either order gets filled, the remaining order is canceled automatically. (Learn more about these and other exit order options.)
Limit orders and stop-loss orders can be great ways to manage your trades if you can’t—or just don’t want to—watch the market on a continual basis. But if you plan to be in front of your computer when you trade, alerts on the thinkorswim platform can let you know when the time for an exit is near.
For example, instead of entering an order to sell the above call option when it reaches $4, you could choose to set an alert to let you know when the bid price has reached your target, as shown in figure 1. You can then cue up a sell ticket and hit the bid to close the position. If immediacy is not a priority, you may choose to be alerted via email or text. But remember, there is no guarantee that the bid will still be there when you log in.
FIGURE 1: CREATE AN ALERT ON PRICE.
Image source: thinkorswim® platform from TD Ameritrade. From the Charts tab, right-click on a chart and click Create Alert, then set your preferences. For illustrative purposes only.
Regardless of how you choose to exit a position, many traders would say that it’s key to stay true to your objectives and exit the trade when the time has come. Yes, that means you may sometimes be closing for a loss. That’s the way the cookie crumbles, as they say. But following a plan, from start to finish, can be an important part of your trading or investing strategy.
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Content intended for educational/informational purposes only. Not investment advice, or a recommendation of any security, strategy, or account type.
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Upon activation, a stop market order becomes a market order. The benefit of a stop market order is that it will seek immediate execution once the activation price has been reached. The disadvantage of a stop market order is that the client does not have any control over the price at which the order executes. There is no guarantee that the execution price will be equal to or near the activation price.
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