Before you even start trading and putting your money into options, you must have an exit strategy ready. This is a very important lesson every trader and would-be trader should know. Without one, it is very easy to continue trading even when it is time to pack up and call it a day.
Money management is, indeed, a very important lesson everyone must learn. It is an aspect of trading which must be understood thoroughly. Trading without any type of exit strategy is likely to lead to premature profits and losses. What exit strategies are available? How can they be used?
Making an exit
There are two ways for investors to get out of a trade. They can take a loss or they can take a gain. When exit strategies are discussed, the terms stop-loss and take-profit will always be discussed. These terms are more commonly abbreviated as T/P and S/L.
Stop loss (S/L)
Stop losses, sometimes called stops, are orders placed by brokers to sell equities automatically at a particular price or point. When the point has been reached, the stop-loss will be converted into a market order to sell automatically.
Rules for stop-loss orders
Orders for stop-loss are constantly over the market’s asking price on a buy, and they are always under the current price on a sell. There are minor differences, of course, when it comes to NYSE, AMEX, or and Nasdaq stop losses.
Types of stop-loss orders
There are three types of stop-loss orders: GTC (good till cancelled), day order, and trailing stop. Good till cancelled means that the order stands until it is cancelled manually or until an execution occurs. Day orders expire after a single trading day, and a trailing stop follows a set distance from the market price; however, it never moves down.
Take profit (T/P)
Take profits are also known as limit orders. It is similar to a stop-loss order because it is also converted to market orders to sell when a certain point is reached. It also adheres to similar rules as stop-loss points when it comes to execution in the various stock exchanges.
However, the absence of the trailing point and the exit point must always be above the current market price, and never below.
Developing your exit strategy
When you begin developing your exit strategy, there are three important things you must not forget. If you are trading for the long term, you need to focus on trailing stop-loss points, setting profit targets, taking profit increments, making exit strategies according to fundamental factors, and allowing some room for volatility.
If you are trading for the short term, you should set near-term profit targets, create exit strategies based on fundamental and technical factors, and develop solid stop-loss points. Your options trading system should be different than someone who is trading for the long term.
Putting things into action
After you have thought and formulated your exit strategy, it is time to put things into action. Exit points should be entered immediately after you have placed your primary trade.