The success of every trade involves three elements: the entry, the exit, and what happens in between. Here’s a look at the trade life cycle.
What do you remember about your first trade? If you’re like many traders and investors, you can recall quite a few details about that first plunge. What made you decide to make that trade at that time? Had you just obtained your first investable assets—maybe a paycheck, bonus, gift, or inheritance? Were you nervous?
Perhaps as important as those details were the logistical details of the trade. Was it made online, via touch tone, or on the phone with a live broker? How did you research that first trade? Did you employ technical analysis, fundamental analysis, or both? Do you still have the position in your portfolio, or have you since closed that position? What did you learn from the process, and what have you learned since then?
The success of every trade is defined by three elements:
Here’s a look at the ins and outs of trade entry and exit strategies—the decision-making process, the signals and patterns, the tools that can help you decide when to get in and out of a trade, and what to consider while a position is on the books.
Understanding the full trade life cycle from start to finish, plus the mechanics and thought processes that accompany each phase, may help you more fully pursue your trading and investing goals.
So you’ve got your trading account open and you’re ready to trade, huh? Well, don’t hit that big green or red button just yet; it’s not enough to just want to trade. The first step in trading should be to define the reason for the trade, which should be more than just a gut feeling or your brother-in-law’s opinion. You should have a thorough understanding of why you’re making this trade, and in general, objectivity is better than subjectivity. Many traders say that subjectivity can invite fear, greed, and a host of other factors that lead to bad decision-making.
It may help to ask yourself, “What’s my objective in making this trade?” And most likely, “making money” isn’t going to cut it as an answer. Perhaps you’re eyeing an earnings report as the springboard for a move. Or maybe a stock you’ve been watching move lower looks to have found a bottom and may be heading higher. Maybe you just want to get in on a stock that’s trending. Whatever the reason, having a solid objective not only helps define your reason for getting into a trade, but it can also help you get out of a trade.
Fortunately, the thinkorswim platform from TD Ameritrade is chock full of tools to make it easier to define your objective. For example, you might start with technical analysis—charts and indicators that help identify areas of support, resistance, trends, and momentum in historical price movements. The thinkorswim platform can also help you with fundamental analysis. Publicly held companies are required to publish their financial statements on a quarterly and annual basis.
Rather than spend hours scouring the internet to gather company information, you can simply log in to thinkorswim. Under the Analyze tab, select Fundamentals, where you’ll find a plethora of company information from activity ratios to valuations. Fundamental analysis alone might form the basis for your trade, or it could be used in conjunction with your technical analysis. Additional information tools include live news feeds, custom watchlists, Trader TV, and access to tons of free education. The tools are there; the choice is yours (see figure 1).
Your trade objective might pull from several sources, such as a bullish technical signal plus a strong earnings release bolstered by a news item. Three strong signals form a much more reasoned objective than, say, hearing your brother-in-law talk about how awesome the stock is.
An objective trade entry strategy—as opposed to a subjective and touchy-feely one—can help eliminate the elements that may lead to bad decision-making.
Are you ready? You may proceed with the trade.
Now that you have your trade on, what’s next? Start sweating? Log in and stare at the screen for hours at a time? Let’s hope not. Rather, consider these ideas for navigating the time between the entry and exit of a trade.
FIGURE 2: MAY I HAVE YOUR ATTENTION, PLEASE? Setting alerts on the thinkorswim platform by TD Ameritrade. Under the MarketWatch tab, select Alerts, enter your stock symbol, select Study Alert, and enter your parameters, such as a new price high or low, or a technical trigger such as a crossover. Not a recommendation. For illustrative purposes only. Past performance does not guarantee future results.
Instead of (or in addition to) alerts, you can place orders to be filled should your trade hit certain price targets. Many traders use conditional orders such as OCO (one-cancels-other) or bracket orders to help them implement the age-old adage of riding your winning trades and cutting your losers.
Some traders also look at a trade’s opportunity cost, meaning they consider not just the funds allocated to a trade, but also the funds’ value relative to potential other investments or uses. Opportunity cost can also include the time you spend watching your trades. Babysitting can be a great job for a teenager, but as a trader or investor, you probably have other demands on your time.
Sometimes it takes days or weeks for a strategy to play out. But the the next decision in the trade life cycle isn’t limited to "sell or hold." You may also choose to make adjustments to your trade. For example, you might sell a covered call to potentially generate income from a long stock position or purchase a protective put to help limit downside risk. Or perhaps you have an open options position. Depending on how the market fluctuates before expiration, you may choose to trade additional options to overlay the position or even roll your current position to another position.
Why would you consider making such an adjustment? Isn’t it simpler to just close the trade? There certainly are times when that’s the best decision. For example, if you have a long position in a stock and your objective has been met, or the reasons that motivated your trade entry no longer apply, there may be no reason to hang around. But sometimes adjustments do make sense. You may be able to reduce the risk of a position, or if there’s an expiration date, give yourself more time.
When trading options or adding an options overlay to an existing stock position, there are many choices of strategies, strikes, and expiration dates. But it’s important to note that options trading can carry significant risk, and choosing among strikes and expiration dates involves balancing risk and return.
OK, you’ve set your objectives, initiated a position, and perhaps traded around it or even added to it. But when is it time to close the trade? And how should you close it? Here are a few considerations when deciding among trade exit strategies.
Regardless of how you choose to exit a position, many traders recommend staying true to your objectives and exiting the trade when the time has come. Yes, that means you may sometimes be closing the trade at a loss. That’s the way the cookie crumbles. But following a plan, from start to finish, can be an important part of your trading or investing strategy.
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