Trade Life Cycles: Entry and Exit Strategies

The success of every trade is defined by entry and exit points, as well as what happens in between. Understanding the full trade life cycle from start to finish, plus the mechanics and thought processes that accompany each phase, may help investors more fully pursue their trading and investing goals.

The first step in trading is to define the reason for the trade. A trader should have a thorough understanding of why they're making the trade, and in general, objectivity is better than subjectivity. Some traders believe that subjectivity can invite fear, greed and other factors that can lead to bad decision-making.

Consider the objective of the trade. What will the trade accomplish? Is the trade related to an earnings report or a change in direction for a stock price? It could be important for a trade to align with a trader's general portfolio strategy and goals.

The thinkorswim^® platform offers a variety of technical analysis¹ and fundamental analysis² tools designed to review different aspects of assets and use that information to define a trading objective. Additional information tools include live news feeds, custom watchlists, and access to a myriad of education resources.

A trade objective might be pulled from several sources, such as a bullish technical signal plus a strong earnings release bolstered by a news item. Three strong signals might inform a reasoned objective, as opposed to relying on a gut feeling.

An objective trade entry strategy—as opposed to a subjective strategy—can help eliminate the elements that may lead to bad decision-making.

The time between the entry and exit on a trade is sometimes called the holding period. Here are some ideas for managing emotions during the holding period.

New traders can get caught up in over-monitoring their positions. Veteran traders often understand that reviewing the position depends on the situation. A short-term stock trade or an options contract close to expiration might require a little extra attention. On the other hand, a dividend-paying stock meant for long-term holding could potentially need less regular monitoring.

The thinkorswim platform can make it simpler to track trades. Under the MarketWatch tab, select Alerts and enter a ticker symbol. The Alerts function monitors criteria like price or volatility levels, technical signals like crossovers, or fundamental triggers like dividend or earnings information. Alerts can be sent by email or text, and they can be viewed while you're logged in to the platform.

Additionally, it's possible to set up orders to be filled when a trade hits certain selected targets. Many traders use conditional orders, such as OCO (one-cancels-other) or bracket orders, to help them implement their strategies without constant monitoring.

Although longer-term trades generally require less time spent on trade management than shorter-term trades, some monitoring is warranted. For example, with a longer-term trade based on a fundamental signal, any significant change in the fundamentals could be reason to close the trade. In technical analysis, if a trend breaks down, it might be time to exit, regardless of the trade's value. Review the reasons for the trade. If the reasons no longer apply, even if the trade hasn't hit a profit or loss target, it may be time to reassess holding the trade in your portfolio.

Some traders also look at a trade's opportunity cost, meaning they consider not just the funds allocated to a trade but also the funds' value relative to other potential investments or uses. Opportunity cost can also include the time spent watching trades. If constant monitoring keeps a trader from accomplishing other goals, it might be time to consider moving on.

Sometimes it takes days or weeks for a strategy to play out. But the next decision in the trade life cycle isn’t limited to "sell or hold." It's also possible to make adjustments to a trade. For example, a trader might sell a covered call³ to potentially generate income from a long stock position or purchase a protective put⁴ to help limit downside risk.

When trading options or adding options positions to an existing stock position, there are many strategies, strikes, and expiration dates to choose from. It's important to note that options trading can carry significant risk and choosing among strikes and expiration dates involves balancing risks and potential returns.

Exiting a trade requires careful thought and attention to your objectives. Here are two considerations when deciding among trade exit strategies.

The original trade objectives used as an example earlier included a bullish technical signal, plus a strong earnings release that is bolstered by a news item.

There are some potential considerations when analyzing whether it's time to close a trade. Consider looking at news events, as well as using technical analysis and fundamental analysis. If one or more of the reasons a trader entered a trade no longer apply, that might be reason enough to close the trade. Perhaps the next earnings report didn't follow through on the previously reported strength, or maybe technical analysis identified a resistance⁵ level or other potentially bearish signal.

If the reason for the trade no longer exists, it might be time to liquidate, regardless of profit or loss. No one likes losing trades, but closing a losing trade can free up capital for the next trade.

Another reason could be key numbers related to your objective. Some traders set percentage gain and loss objectives, such as a 5% gain versus a 2% loss. Others set exit points in dollar terms. For a $150 stock, that would translate to a gain of $7.50 per share versus a loss of $3 per share.

The thinkorswim platform can be configured to provide alerts when an exit point nears. There are different choices for exiting the trade, including a basic order type like a limit order⁶.

It's also possible to enter this trade as good 'til canceled (GTC). In this case, the order is good either until it's filled (for up to six months) or until it's canceled. Creating a GTC order versus a regular day order means there's no need to enter the trade each day until it's filled.

Another strategy is a sell stop order, which automatically executes when a position drops to a specified price point. It's important to note that entering a stop order does not guarantee execution at or near that price. Once activated, the order competes with other incoming market orders.

Limit orders and stop orders are strategies to manage trades if a trader doesn't watch the market on a continual basis.

Regardless of how you choose to exit a position, some traders recommend choosing objectives and exiting the trade when it no longer serves those objectives. Following a plan, from start to finish, can be an important part of your trading or investing strategy.