Entering a trade can be done many different ways and many seasoned traders say that’s the easiest part of trading. However, knowing when to exit makes the difference between making profits or wiping up a trading account completely. Knowing when to exit is critical for cutting bad trades before incurring large losses and letting profit run to maximum potential. So the real dilemma when a trade is on is whether to get out, especially if the trade is profitable.
Letting profit run requires some rules and usually involves the use of an appropriate indicator in order to avoid the traps of fear and greed and either getting out of trade very quickly or very late.
Here is an example of a trade that could have been very profitable in Bitcoin if executed correctly.
For entering the trade we assumed a basic rule of buying once price crosses and closes above the 100 period simple moving average. Now at the start of the trade we do not know how large the potential profit is. And unless we use specific price targets or dollar amounts, the best solution is to use indicators to help us ride the trend and let profits run as long as possible.
Here are the top 3 indicators that can be used for this purpose:
- Moving average: there are many types of moving averages and depending on the methods of calculation and period they tend to follow price either more closely or widely.
For example a 14 period simple moving average will follow the price more closely than the 100 period. Using a 5 period setting will result in the moving average messing with the price more often than not, giving many false signals. In addition, an exponential moving average (EMA) will follow the price more closely than a simple moving average (SMA). Using this indicator in our trend example, we should have been able to capture the largest part of the trend as shown below. But we still left a lot on the table.
- Parabolic SAR: This indicator is one of the best alternatives for trailing stop loss and timing exit, as it tends to follow price with a distance in the beginning of a trend and closer as the trend takes off and matures.
This characteristic makes the Parabolic SAR a brilliant choice for setting for trailing price action with a stop loss order not too close but not too far either. This allows for capturing the best part of a trend. By using this indicator in our trend example, we should have been able to capture a large part of the trend similar to the moving average as shown below. But we still left a lot on the table. Usually the Parabolic SAR will perform better than the average moving average, though.
- ATR Trailing Stops: This indicator does exactly what the name suggests. It is used for trailing price with a stop loss order after a trade is initiated. This indicator takes into account the average volatility of the asset being traded and adjusts continuously.
Although it is a lesser known indicator and not available in every trading platform, it could be the best choice for letting profits run and cutting losses short. The reason for that lies in its calculation method. One one hand that allows it to hold enough distance from a trend to avoid market noise and avoid early triggers. On the other hand, when the trend speeds up, the indicator tightens the distance adequately so if there is a sharp reversal, the indicator will signal a timely exit before profits diminish significantly. By using this indicator in our trend example, we were able to capture the largest possible part of the trend leaving almost nothing on the table.
So having an exit strategy is equally or even more important than having an entry strategy in trading. This is due to the fact that profits and losses are determined at the exit price. This is where trend following indicators like moving averages, Parabolic SAR and ATR Trailing Stops come into play. They can be used to get out of a trade at the best possible time. They can be used to let profits run and cut losses short. Depending on personal preferences all 3 indicators are almost equally good for the task. But if we had to choose one though, this could have been the ATR Trailing Stops. Its ability to time the exit from a trade is unparalleled and usually results in capturing a larger part of a trend, compared to the moving average and Parabolic SAR.