One of the most common questions we get asked is this:
“When exactly should I take a profit?”.
I am sure this is something that you may have wondered about. You may have asked yourself:
“How do I calculate when I should exit a trade?”.
Perhaps you bought a stock or commodity at a low price, but now you’re considering selling it. When do you take a profit?
Believe it or not, the answer to this question is a lot simpler than you may think.
In this essay, I shall reveal to you my #1 rule for when you should take a profit and exit a trade (long or short).
The #1 rule for when you should take a profit goes like this:
“If the reasons for why you entered the trade are no longer present, or if the technicals (or fundamentals) have changed significantly from the time of your entry so that you have no reason to be in the trade, then exit the trade“.
To put it very simply, your reasons for exiting a trade should be based on the same reasons as to why you entered the trade.
This is not just logical and common-sense – it actually works.
Let’s start with a good example.
One of my favourite trade setups is the “pulse signal”. Take a look at this chart which shows what happened to the stock market this month when the pulse signal “fired” long:
When the pulse fired long, as shown when the red dots turned to blue dots on the LT Pulse indicator, this told us that the market was shifting from a period of low volatility to high volatility – with increasing upward momentum.
This was the reason for our entry and “going long” on the Nasdaq. The market rallied after our entry, putting us in profit.
So if we follow our #1 rule, when do we exit?
We will exit the trade when the reasons for our entry are no longer existent, i.e. when the increasing upward momentum AND volatility have ended.
You will see from the chart that the upward momentum ended 12 bars later.
But do we exit here? No.
This is because the first reason for our entry was increasing volatility. The LT Trend “coloured” bars are based on the volatility of the market. As long as the bars are still blue, the upward volatility is still existent.
We need to wait for 2 consecutive red LT Trend bars for exiting this trade, because this shows that the upward volatility has come to an end.
This happened the next day. Once we got those 2 consecutive red bars, we had no reason to be in this trade! So we exited this trade for just over 100 points profit.
This was a simple example – but here are some even simpler examples of when you should exit a trade:
1) If you bought a stock when it was “undervalued”, you can sell it for profit when the price becomes “fair” or “overvalued”.
2) If you shorted a commodity because it is in a downward trend, you exit your short (“buy back”) when the trend reverses (e.g. it rallies and closes above a downtrend line).
3) If you follow “Elliott Waves” and you bought a stock at the end of wave 4, then you sell it at the end of wave 5.
Notice that in every one of the above examples, our reason for exiting a trade is based on the reasons for our entry.
Again, if the reasons for your entry are no longer existent, consider taking a profit.
One of the best people I know who has made a science of profit taking is my good friend and fellow trader, Simon Shepherd.
Simon uses a secret and powerful method for setting precise targets for his exits, and the accuracy of his system for exiting trades is simply amazing!
For more tips and strategies on trading the markets, try our trading service.