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Exit strategies

The long-term buy-and-hold investor rarely contemplates selling an investment position.
However, the astute investor/trader who wants to protect capital and capture profits
carefully considers the possibilities for exit strategies, and
ruthlessly implements the chosen strategies.

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Related links: Robert's Philosophy; Share Market GEMs; Share-Market-Ready; Paper Trading; Market Indexes;
 Stop LossSupport and ResistanceTrend-spotting;
 Funda-Technical Analysis; Sensible Investing; Contrarian Investing Redefined; Technical Analysis;

More Information

Slide presentations - There is some preliminary and basic information in some of the slide presentations that Robert has prepared and delivered at various meetings.
  • Exit Strategies - A presentation on Exit Strategies that provides an overview to the related eBook Articles listed below, and presented to the ATAA Newcastle group (Nov 2015). It includes Speaker Notes for Premium Toolbox Members.
  • Stop Loss - Introduction - A basic and simple introduction to the topic, presented to a User Group in 2007. It includes Speaker Notes for Premium Toolbox Members.
  • Seven ways to determine a Stop Loss - A simple presentation that lists and displays several ways to determine a Stop Loss.
eBook Articles - Share Market Toolbox Members can see more details in the following eBook Articles:
(Toolbox non-Members can see the "Page 1" of these Articles from the Master List page.)

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Terminology
There are a number of terms that are used in the text at left, including: Stop Loss, Support, Parabolic-SAR.
 
There is information on these in Brainy's eBook Articles. See the Master Index list for details.
 
Or, search the eBook Articles.

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Introduction

Why should we consider implementing an exit strategy, and not just buy-and-hold? 

We know that a market correction, or even a bear market, comes around too often, and that it can be very prudent to capture profits and protect capital at various times through the economic cycle. Not convinced? See more details about corrections and bears...

Don't forget that the opinions and emotions of market participants
are summarised in the price charts, and
every chart has a story to tell.
These stories can help us with a wise choice of exit strategy.

Reasons for exiting

When we exit from a position it could be for one of a number of reasons including the following:

  1. For a new investment position, the share price has fallen and our investment decision on this occasion was not a good one, so we sell based on our pre-determined Stop Loss approach.
  2. The money is needed elsewhere, so we liquidate a position in order to redeploy the cash.
  3. The investment value has risen significantly, making it somewhat sensible to liquidate some or all of the position, perhaps to re-balance the allocation of our funds or to reduce the risks of this particular investment (eg. the portfolio weighting risk). 
  4. The investment has risen to a pre-determined price target, so we want to lock in the profits and exit the position.
  5. The investment position is not going anywhere and our money is not working hard enough (opportunity cost), so we liquidate in order to redeploy the capital elsewhere for a better performance.

Exit strategy options

Regarding the detail for an exit strategy, there are many different approaches that can be considered, and they tend to fall into the following general categories which are briefly explained below, with more detail available (see the relevant links below and at right):

  • Time, clock or calendar-based exits;
  • Price target exits;
  • Money-based exits, basically a Stop Loss (based on the share price value);
  • Price chart feature exits;
  • Chart indicator exits.

The common "percentage fall" approach

This approach is commonly used by investors who don't understand the usefulness of spotting support and resistance levels on a price chart. But is it at all useful?

Selling on price weakness

For many people, it makes sense to sell on price weakness. but how do we spot this?

Time, clock or calendar-based exits

There are a number of possible considerations regarding the time of day or day of the week that tend to be a little easier for decision-making regarding exits, or even entries. Perhaps the most useful time-based approach is the situation where a price does not advance as expected, hence the opportunity cost of holding the position means it might be best to sell and invest elsewhere.

Price target exits

Many investors and traders have the view that as the share price rises there will be an upper price level where a rising share price might pause, or even sell off. Assuming that this will pan out, the intention is to take some profit by closing a part of the position, or even the whole position. This involves setting a price target, based on some specific criteria. In some cases, the investor might close the position at this price level regardless, and then feel good about holding the profits, while others will be cautious as the price approaches that level and will be quick to sell only if the price hesitates.

There is another situation where investors utilise a price target. And that is in consideration of the Risk/Reward Ratio. Many investors consider this ratio before entering an investment so that they can avoid those positions that might have a low reward for the amount of money being put at risk.

The list of options includes: overhead resistance (on the price chart), the Measure Rule, a round price value (such as a whole dollar amount), or utilising the ideas of Elliott Wave, or of Gann.

Money-based exits (based on the share price value)

There are several exit methods that can be used to set an exit price based on the recent share price action - basically a simple Stop Loss. Some of these options include: a straight percentage of price (not this commentator's suggested option), stop loss at recent price chart support, or a Fibonacci extension.

Price chart feature, and chart tool, exits

There are a number of ways that an exit strategy can be determined based on features of the price chart that may result in the stop loss value changing from day to day. These might be features of the price chart, or utilising a simple tool on the price chart (but not an indicator). Some of these possibilities include: 

  • support or resistance levels,
  • break of a trend line
  • change of trend, 
  • Lowest Low of the Last "n" Bars, 
  • Count Back Line (CBL), 
  • pivot point reversal pattern, 
  • candlestick reversal pattern,
  • chart patterns (eg. failure of a triangle pattern, etc.),
  • Fibonacci retracement, or extension.

Price chart indicator exits

Many people like to follow the action of a chart indicator such as the Moving Average (MA) on a price chart, and note whether the price is above or below the MA (as per Stan Weinstein's approach). Even though this is an application of technical analysis, many people use it without considering that it is technical analysis. Some of the possible technical analysis chart indicators that can be utilised to help identify a potential exit include the following: 

  • Moving Average (MA)
  • Moving Average cross-over (eg. 7 and 12 period, or 9 and 12), 
  • Parabolic SAR, 
  • Bollinger Bands, 
  • ATR-based indicators, 
  • Williams percent R,
  • Chandelier Stop,
  • Wilson ATR Trailing Stop,
  • Hull Range indicator, 
  • Jim Berg Volatility Profit Taker indicator,
  • Jim Berg Trailing Stop.

Other exit approaches

Here is one exit strategy that does not readily fit into the above classifications. It is based on compiling a list of candidate stocks, and then applying a ranking to each stock, and sorting the list by rank. If the available investment capital is not enough to invest in every stock on the list, then only invest in those stocks at the top of the list. If a currently held stock is listed further down the list, then sell it and redeploy the funds to buy a stock which is further up the list.

Why not use fundamental analysis to exit a position?

This question gets back to the basis for our use of technical analysis - the fact that the opinions of the market participants are summarised in the price charts (as stated above). Many investors agree that almost all of the information that we need is already in the price chart, so there is little need to consider the Pandora's Box of fundamental analysis. That is, any intrinsic value, or fair value, of a stock is mostly not relevant.

One sample approach to exitsConclusion

A sensible exit strategy approach can be very useful, and in many cases can be based on a feature on the price, or utilising a technical analysis tool.

How do some people do it?

Following is one example approach to exit strategies (with no guarantee that it is useful or successful in all market conditions, nor in the hands of other traders or investors).

I believe that in times of market uncertainty (as seen at least in the 10 year period from 2007 to 2017), it is difficult to have a simple exit strategy that utilises just one, or even two, considerations.  This makes it difficult to automate the process. The price chart at right shows several technical analysis observations that can be used (click on the chart for a larger version), including:

  • A falling Moving Average of price.
  • A chart indicator that provides a Trailing Stop (such as the Wilson ATR Trailing Stop).
  • Momentum chart indicator peaks and falls.
  • The Moving Average of the Momentum flattens and falls.
  • The Momentum indicator falls below its own Moving Average.
  • The MACD curve peaks and falls sharply, esepcially below its zero level.
  • The MACD crosses below its Signal Line.
  • Twiggs Money Flow is below its zero, and trends lower.

More information

For more information on this topic, see the list of references in the column at right...



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Last revised: 20 May 2017