| Positive Territory does not indicate when to sell.
We let the market tell us. The market does not always speak clearly
so here we will review a few of the many possible exit points. All
exits can be broadly classified as either loss limiters
or gain gatherers.
Generally, Loss Limiters are designed to put a limit on
your downside risk. Gain Gatherers are designed to keep
unrealized gains in your pocket and not let a downward price movement
take too much of that gain. Sometimes an exit can start as a loss
limiter and become a gain gatherer due to ratcheting (see stop
loss below) during a price rise.
There are many varieties of exits including the Stop
Loss Exit, Event Driven Exit,
Moving Average Cross Under Exit
and Others. We start with
stop loss below.
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Stop Loss Exits
Perhaps the most common loss limiter is the stop loss. Generally
set in dollars it is often expressed as a percentage of purchase
price. For example: A 5% stop loss on a $20/share purchase would
be
stop loss = $20 – ( 5% * $20) = $20 - $1 or $19
If a $19 stop loss was in effect, and the price fell to $19, the
holding would be sold. It is important to remember that the stop
loss is effective during the whole trading day. If the stock opened
at 19.50, had a high of 21.20, a low of 18.95 and closed at 19.20
your holding would have been sold as the price went below the stop
price toward the low of the day.
Generally your holding won't be executed based on after-market
or pre-market activity. So if the close was 19.20 (and you were
still holding), after market prices went to 18.75 and pre-market
activity on the next day went to 18.96, you would still be holding.
If the opening price was below your stop, your stop loss order would
be executed.
The more common stop loss causes your stop loss order to be placed
as sale-at-market. When the order is placed you get the price the
market dictates at the time the order is placed. So, if opening
price was $16 per share, your $19 stop loss would be placed at market
and you'd get less than the $19 you'd expect.
There is also a stop loss limit order.
This places your stop loss not as a market order, but as a limit
order. That is: $19 or nothing. This can have materially more risk.
If the opening price was $16 per share your stop order would be
placed as a sale-at-limit. It would not be executed because few
buyers would purchase your shares at $19 when they could get them
from the market at $16. After not filling the order there are two
other possibilities, both with bad consequences. The stock could
rally and rise significantly after a terrible opening. Your sale-at-limit
order of $19 would be filled on the way up. The other possibility
is that the stock continues to decline, and decline, and decline.
You would still be holding. Stop loss limit orders can have very
unfortunate consequences and are not recommended for novice or average
investors.
You can can change stop loss orders. Your broker may charge you
for this (hopefully not!). So, why would you change a stop loss?
Upward ratchets are one good reason. Say your $20 purchase closed
at $21 after a time. You might want to change your stop loss
Was stop loss = $20 – ( 5% * $20) = $20 - $1 or $19.00
Now stop loss = $21 – ( 5% * $21) = $21 - $1.05 or $19.95
The base changes from $20 (purchase price) to $21 (new closing
price). So now, if the price falls to $19.90 your stop-loss-sale-at-market
would net you only a $0.10 loss instead of a $1.00 loss.
Consider the next cycle. After a while longer the price closes
at $25.00. You could sell at a nice profit, but you want to stay
in because you think the price will continue to rise. You can change
the stop loss again.
Was stop loss = $21 – ( 5% * $21) = $21 - $1.05 or $19.95
Now stop loss = $25 – ( 5% * $25) = $25 - $1.25 or $23.75
Your stop loss is now above your purchase price. Absent any disastrous
price movement you have protected a $3.75 gain.Or, because you are
now in a gain position you might allow yourself a little more risk
and use a 7% stop loss instead of 5% stop loss.
Tight stop loss orders (meaning low percentages)
can execute faster than you expect. Loose stop loss orders (higher
percentages) can expose you to more risk. Your risk tolerance will
guide which is right for you. Before risking real money try paper
trading and see if you need to invest in antacids at some point.
Investing should be exciting and not a cause for indigestion.
Loose or tight, stop loss orders are fundamental protection and
are highly recommended.
There are many variations on the percentage stop loss. The amount
to risk can be based on the Average True
Range (ATR), some multiple of ATR, some function of the spread
between the day's high and low, the spread between open and close,
literally hundreds of options are available.
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Event Driven Exits
The percentage of purchase
price stop loss is a way of using a single price (usually purchase
and perhaps closing price) and a single parameter (your risk tolerance
expressed as a percentage you are willing to risk losing) to determine
a point at which you are willing to sell. More information can let
you create and use more complex exits
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Moving Average Cross Under
This exit uses historical closing prices to create two lines. The
first is a faster moving average than the second. In this context,
faster means that it is more responsive to price movement. The fastest
response is when it is a simple moving average of one period. This
is just the closing price on its own. When the faster moving average
crosses under the slower moving average the price is generally anticipated
to go down. Maybe this is time to exit?
This one moves slowly
SMA(50)(Closing
Price) x- SMA(200)(Closing
Price)
- For more on the 50/200
cross over see SMA(50/200)
Faster
SMA(4)(Closing Price) x- SMA(9)(Closing Price)
Very Fast
(Closing Price) x- SMA(4)(Closing Price)
- See also the technical
analysis explanation for SMA199
Some brokerage firms allow the placement of an order to execute
when such a condition is created. Again, considerable caution is
required. If the two lines change rapidly during the trading day
your position could be sold-at-market right after a price drop preceding
a price rise.
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Other Exits
There are many possible exit strategies and you need to choose
your own. Some traders consider an exit the next day if that night's Parabolic
Stop and Reverse (PSAR) changes from green to red. Or, if the
number of Or, if the number of total
cumulative positive developments (TCPD) count drops. Or, if
the weather turns cold in the east while
raining in the north. There are many, many possibilities.
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