There are a million and one ways to exit a trade, so here’s an approach that will benefit the individual trader, looking to stay in those winners longer.
When we first get into a trade with an initial stop loss, our entire position is at risk, but once the trade starts to go our way I find it extremely helpful to take a little off the table. This does two things.
- It allows for the reduction of risk.
- It releases pressure from our emotions.
#1 Reducing Risk. The objective of a first target on a trade is to take a little off the table and ideally get you in a position where your worst case scenario is break even. What is crucial here, is that your first exit is at least 1:1 reward to risk. I like to use 1.5:1.
So for example on my ES (E-mini S&P 500 futures) day trades, I start with a 2 point stop loss and then split the position in half using a 3 point first target and a trail stop on the second half (more on this in a bit).
This 3 point first target allows me to reduce my risk on the position to the point that my worst case scenario is walking away with +1 pt, not bad. And for a market that has a lot of movement, it’s not too difficult to get that 3 points hit.
#2 Emotional Release. The objective of trading is to maximize gains while minimizing loss, but we all know those pesky emotions get in the way. When you get a first target hit and reduce your risk you now free up your emotional state to be able to let the winner run.
I like to trail swing highs/lows as the trade goes in my favor. Knowing that my worst case scenario is break-even or in the case of the ES example above +1 point, I’m able to stick to the trail stop plan and hang on longer without the fear emotion getting in the way.
This approach can be used on day trading and swing trading. Just remember to keep that first target to at least 1:1 reward to risk. You don’t want to be risking 1 and taking half the position off for .25 reward. Your 2nd half would then have to be a knockout homerun just to end up with an overall 1:1 reward to risk on the position.
The author has a position in mentioned securities at the time of publication. Any opinions expressed herein are solely those of the author, and do not in any way represent the views or opinions of any other person or entity.