Episode 4 – Exit Strategies for trading June 22, 2022

In this article, we will share tips you can use to identify or set potential exit points for trades. In the previous episode, we covered entry strategies, and for every entry, there has to be an exit. Traders will also need to set exit positions or strategies to reduce risks while maximising potential rewards.

Determining both an entry point and exit point prior to trading is important. Traders must ensure the distance between the entry and exit points is in line with their risk-reward ratio in order to earn profits in the long run.

An exit point refers to the price at which a trader closes a position for any financial product (stocks, CFDs, forex, etc). A trade exit will be matched with an open position by doing the opposite action of the open position. Either a sell for a buy/long position or buy for a sell/short position.
A good exit point is important to reduce emotional trades based on market volatility. It can predetermine a successful long term trading strategy as it minimises the “human” element with regard to trading decisions.

An exit strategy strives to allow traders to profit on winning trades and cut their losses earlier from the underperforming ones, leading to net positive returns in their overall trading activity. This is also a reason why it is critical to consider the risk to reward ratio when determining entry and exit points.

Using Technical Analysis to determine exit levels

1. In the previous episode, we touched on how Support and Resistance function as a price floor and ceiling, and how to use this information to determine an entry level. In a similar fashion, this information will be able to provide an exit level as well.

2. Stop loss – If a position is entered based on a support line, a potential exit point would be if the support line is breached beyond a percentage of loss predetermined by the trader’s risk analysis. Similarly, if a trade is entered based on the uptrend after a resistance is broken, the resistance level is now treated as the new support level for the trade.

Setting an exit level using Resistance-turned-Support Line

Figure 1. Chart of CapitaLand Integrated Commercial Trust with resistance at 2.18

Long traders may wait for the price to break above the resistance line before entering into a long position. Once the price breaks above the resistance area, the supposed resistance level can turn into support level, it is then assumed that the buying power has exceeded the selling power, which may result in more upside in the near future.

Example of using Resistance turned Support Line as an exit point from CICT price chart

Based on Figure 1, the resistance level for CapitaLand Integrated Commercial Trust was at S$2.18. If a long position was entered based on this resistance turned support level, the trader might have entered after the price retraced to near S$2.18 and rebounded off confirming it as a new support level.

As there are traders who target other traders/investors’ stop loss level, the stop loss should not be too near the exact support level of S$2.18. However, the range does depend on the risk appetite of the trader and one alternative way to gauge is to find another support level from the chart even if it is a weak support. From the chart, the S$2.10 level can be seen as a level where the price reacts and can be considered an exit point. Assuming the entry was at S$2.20, stop losses at the S$2.10 exit level, which will result in a loss of around 4.5%.

3. Take Profit –

1. After determining a stop loss level, you can use your risk to reward ratio to determine a take profit level. Assuming the risk to reward ratio is at 1:2, the take profit level of the above example would be S$2.40.
2. Another method is by looking at the next resistance level and adjusting the take profit level. From Figure 1, the price hit a recent high of $2.36 before a correction. Therefore, the profit level of S$2.40 might not be achievable, traders may instead look towards the S$2.35 to S$2.36 levels.
3. Other technical trends or indicators may be used to determine the next resistance level if there has been a short term uptrend with no correction. On an uptrend channel, the resistance is observed based on the upper trend line which might be parallel to the main bottom trend line.

Determining exit levels during an uptrend

Figure 2. Chart of Suntec REIT showing an uptrend

Example of using upward sloping trendlines as an exit point from the Suntec REIT price chart

Using a similar example from the previous episode, a long position may be entered when the price movement adheres to the uptrend line, preferably after rebounding from the point it touches the uptrend line.

For example, when the price moved to the S$1.60 level range after rising from the S$1.52 to S$1.55 range. If a trader chooses to enter a long position based on the uptrend at this point, the stop loss level can be determined with a percentage level range, for example at a 5% loss which will be at the S$1.52 level. Alternatively, it can also be determined at the previous low within the uptrend which can be either the S$1.52 or the S$1.47 level.

As the uptrend continues, traders can adjust the take profit and stop loss levels to attempt to maximise profit while protecting the profits already made. For example, when the price moves in an uptrend manner to hit a high of S$1.86, the previous correction low of S$1.75 can be set as the new stop loss if the trader does not wish to take their profit at S$1.86 in view of further potential.

Based on the extended uptrend line earlier drawn, if the price touches and breaks through the support of the uptrend line and the level coincides with the stop loss level, the price to be considered is S$1.75. If the trader closes off here, the max profit of 16.3% is missed assuming an entry at S$1.60, but a profit of around 9.4% is retained at the adjusted stop loss level to protect profits.

Using company fundamental data to determine exit levels

1. Other than the use of technical analysis, fundamental analysis can also play a part for traders. Research reports released by research houses and teams are available for investors and traders to utilise to evaluate their investment or trading choices.

1. Trading on a counter which has good fundamentals would provide more faith in the trade’s success, if it coincides with a potential long/buy position to be taken up by a trader.
2. Instead of looking at the buy/hold/sell calls by the research houses, the more important factor to note is any upgrade or downgrade of the target price, and what factors were mentioned to contribute to the change in the target price.
3. In an environment of rising interest rates, the discount rates used for calculation of intrinsic value of a firm to determine the target price will be impacted to varying degrees depending on the industry and country the firm is operating in.

2. Earnings reports and annual reports released by companies are also often accompanied by volatile price movements in the days after, due to the potential disparity of the expectation versus actual performance of the company. Some companies also provide profit or revenue guidance based on the fundamentals of the company or industry.

3. During this period, if traders are using take profit and stop loss strategies which are relatively tight in terms of range, they may see their positions closed before their intentions.

1. Avoid short-term trades during period of volatility unless you have an understanding and expectation of the counter’s performance and are willing to take the risk.
2. Adjust stop loss and take profit levels to allow counters to move during a volatile period but be prepared to spend more time monitoring the positions.
3. Participate in price movements by acting before actual earnings results are out. For example, if a company is expected to announce positive results due to competitors’ performance, short-term long trade can be entered but closed before the actual release of results.
4. Traders with longer term horizons should also review any fundamental changes in the company’s ability to generate long term growth in revenue or sustainable profits to perhaps cut loss early and move on to other counters if factors that led to that counter’s selection is no longer valid.
1. For example, some traders may invest into Telecommunication companies for stable dividend and potential growth due to advancing technologies such as 4G and 5G networks.
2. However, due to higher costs of labour, network setup and slowing growth within the industry, telecommunication companies may see the operating costs affect dividend distributions levels as well as revenue and profit margins in the short term.
3. Traders may look to exit positions in the company first until more developments are known about the introduction of the new technologies.

Using macro-economic factors to determine exit levels

1.Traders should also consider macroeconomic factors which could lead to short-term swings in the overall markets. Comparing the impact of previously similar situations to current situations may give more insights to how the market may move in the short, medium and longer term trading horizons.

2. Factors which are important to look at:

1. World/Country’s GDP growth estimates – focusing on the change in expectation from previous estimates and any factors announced
2. Interest rate environment – affects cost of borrowing/operations for companies. Also impacts the growth of companies due to the impact of the discount value used in valuation of such companies.
3. Fiscal policy –
   1. Negative – trade tariffs due to trade tensions, potential regulatory clampdown on certain industries such as traditional energy/gaming/e-commerce/social media.
   2. Positive – Support such as tax rebates or subsidies for certain industries such as Electric Vehicles and the renewable energy sectors. Infrastructure spending to be beneficial to the economy in general but particularly to the construction and logistics sectors.
4. Inflation/Currency exchange rate – Impacts on export and import attractiveness and consumer spending

Summary

There are numerous factors and considerations when setting an exit level for an open position. Those mentioned are just a few examples which can be considered in a trading strategy. Investors may look at technical indicators, trends, micro/macroeconomic factors and a company’s recent news and financial performance to determine any adjustments for their exit strategy.

As a guiding point, traders can consider setting a preferred exit level such as 5%/10% stop loss and based on risk reward ratio, a 10%/20% take profit level. Thereafter, the stop loss and take profit levels can be adjusted based on the preferred considerations such as technical indicators or any recent news or earning results.

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