This post examines longer term trades, not day trades.
You have just put on a trade and you have sized it according to your risk management strategy, which means you have calculated the downside risk before putting on the trade. When this trade starts to work in your favor, what do you do next? When do you exit?
This question comes up often in my discussions with fellow retail traders. It’s always best to know the exit strategy before entering the trade, not only from a risk management perspective but also for managing your winners. One way to know this is to define the trade by asking yourself the following question: is this a swing trade or a position trade?
What is a Swing Trade?
A swing trade looks for short-term price momentum. This type of trade usually lasts 2-10 days. The idea behind swing trading is that institutions trade in too large of a size to be nimble. This gives individual traders an edge in exploiting short-term stock movements without being in direct competition with the big boys.
What is a Position Trade?
A position trade looks to get in on a trend and ride it as long as the trend is still alive. This type of trade lasts anywhere from several weeks to several months (or longer). The idea behind position trading is to ride along with the big boys and profit from the primary trend as new catalysts cause the institutions to pile into the trade in size, driving the price.
Exiting is based on your entrance
It’s obvious from the above definitions that the main difference between these two types of trades is the holding time. So once you have identified the type of trade you are entering, it’s easier to determine when to let go of your winners.
Since the entire life cycle of a swing trade is 2-10 days, it makes sense to use shorter time period moving averages like the 5 or 10 day moving averages to assist you in determining when to exit. Remember, we are talking about trades that are working in your favor here (trades that go against you will be taken out by stops as part of your risk management plan). One way you might handle a winning swing trade is to use the 5 or 10 day moving average as your trailing stop and exit when the stock closes below one of these levels.
Since a position trade occurs over a much longer time period, it makes sense to use longer term moving averages like the 50 or 100 day moving averages to assist you in determining when to exit. The same philosophy applies: as the trade is going your way, use the 50 or 100 day moving average as your trailing stop to help you determine when to exit the trade.
So there you have it, I hope this helps you to think about how you might manage your winners.