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When and how to exit a trade?
A big part of investing is knowing when it’s time to walk away. While that could mean selling out of an underperforming asset, it could also involve exiting a asset that’s climbed in value, but in which further gains may be less certain.
In many cases, it can be helpful to have an exit strategy before you invest. By having that plan in place, you can effectively remove emotions from the selling process, which can result in people selling too early or too late. Fortunately, there are tools out there that can help you exit at the right time, which could potentially help keep you on track with your financial goals.
What is an exit strategy?
Because stock market activity is usually unpredictable, it can be useful to plan in advance how long you want to hold on to an asset. Many investors look for ways to lock in their gains and minimize their losses by strategizing an appropriate time to buy or sell. These exit strategies can act as guardrails to help investors avoid selling an underperforming asset too early or holding on to one that’s outperforming for too long, missing a chance to sell when prices may be near a peak. Portfolios built with defined parameters are generally more successful than those that are guided by emotion. Having an exit strategy in place before you make an investment can help you avoid becoming too attached to the investment.
How to exit a trade?
Market orders
A market order is a trade order to buy or sell an asset at the current market price, which means whatever price the asset is trading for currently will be the executed price. The only exception is when the asset is heavily traded and there are other order executions pending before you, could potentially change the price you pay. A market order will immediately execute a trade at the best available price.
Limit orders
A limit order allows an investor to set a specific price at which the order should be filled. Should the asset reach the specified price, known as the "trigger price," the execution order becomes active. Note that there is no guarantee the order will be filled. If the price of the asset never reaches the limit price, the trade will not take place.
Stop-loss (S/L) orders
A stop-loss order is a passive order type that automatically triggers an order to buy or sell shares of an asset once the market price rises or falls to a certain level. This level is known as the "stop price." Once the "stop price" is reached, it becomes a market order and gets triggered, which means an attempt will be made to fulfill the order and the stock would be filled at the next available price. However, putting a stop-loss in place doesn’t guarantee the asset will be bought or sold at the stop price as the market price could fall further before the order is filled. For example, you have 100 shares of ABC company purchased at $100, you set a stop loss order at $90. The stock continues to decline and falls below $90. Your order will trigger as soon as it reaches the stop price of $90, and your position may be sold for $89. Still, it can be a helpful way to manage an exit. There are two types of stop-loss orders:
Sell-stop order
These are the most common form of stop-loss orders and are often used to help investors limit their potential losses by automatically triggering an order to sell shares once the market price dips to the stop price. They can be particularly useful for people who don’t have the time or desire to monitor the daily movements of the markets. As an example, let's say you buy an asset at $50 per share and it rises to $65. If you place a sell-stop order with a stop price of $60, your shares will be sold at market price once the stock falls to the stop price or below. This would allow you to exit the investment before it potentially falls further and eats away at your gains.
Buy-stop order
A buy-stop or buy-stop limit order, on the other hand, is an order to purchase shares of an asset once the market price has risen to the stop price. It is generally used to protect the profit or limit the loss on a short position. Because short sellers trade securities they do not own, they will incur a loss if forced to buy an asset back at a price higher than they sold it for. For this reason, the buy-stop order would commonly be entered at a stop price above the current market price.
Stop-limit order
This order type is similar to a stop-loss order, but it includes two figures, a stop price and a limit price. Rather than just selling shares at the market price once the price falls to the stop price or below, the stop-limit order will become a limit order once the price falls below the stop price.
For example, if you invest in a company at $60 per share and place a stop-limit order with a stop price of $55 and a limit price of $52, then $52 is the minimum amount of money you are willing to accept for your shares. If the market price of the shares drops to $55 or below, the stop-limit order is converted to a limit order that will only sell shares at $52 or above. This can help protect you from selling a position during periods of short-term market volatility. As with all limit orders, there is no guarantee the sell order will be filled. This is especially true in rapidly declining market environments.
Good ’til cancelled (GTC)
This type of order, as the name implies, remains active until it is either filled or the investor chooses to cancel it. Generally, brokerages limit the maximum time an investor can leave a GTC order open, which can vary depending on the brokerage. For example, TD Direct Investing has set a maximum expiry date of 90 days for Canadian securities and 180 days for U.S. securities.
Day order
These orders remain in place for one trading day before expiring. This type of order typically expires at the end of the standard trading day, which means they are automatically cancelled if not filled by end of the day when market closes. They do not carry over to after-hours trading sessions. If you are entering your order after market hours, a 'Day' order will expire at the end of the next trading day.
Trailing stop
A modification of a regular stop order, a trailing stop is a stop order that automatically adjusts the stop price based new highs or lows achieved by the security price. These orders can be set at a certain percentage or dollar amount away from the market price of an asset. For example, if you invest in a company at $50 per share and then place a trailing stop order to sell with a trailing stop of 10%, it won’t activate until the stock drops to $45 per share. If the stock rises to $60, the trailing stop rises to $54 per share (or 10% of the new share price). Note that the estimated trigger price is updated once an hour starting from 10:30AM ET to 4:30PM ET.
How to place orders?
Creating an exit strategy using stop-loss orders can be straightforward. Some online-trading platforms, such as TD Easy Trade™ and WebBroker from TD Direct Investing, make these order options accessible to investors. The order type and order terms are set when the order is placed. If you decide later that you want to update the order, and the order has not yet been filled, you can cancel the order and re-enter it with different order terms. However, due to normal processing/reporting delays, it's possible that your order may have already been filled but not yet reported to your account. In such cases, you continue to remain responsible for those orders.
How to develop an exit strategy?
Holding period
An exit strategy will depend on an individual investor's financial goals. For example, some long-term investors use trailing stops as a tool to help lock in unrealized gains and preserve capital previously invested. Note that, any time you execute a trade, you may incur a taxable gain, or a loss for tax purposes.
Risk appetite
Tolerance for risk is another component you can consider when devising an exit strategy. Coming up with a realistic estimate of how much money you are willing to lose could help inform your use of stop-loss orders.
Determining an exit point
It can be important to regularly reassess your exit strategy to ensure it is still aligned with your financial goals Determining in advance when you want to exit an investment could prevent you from holding on to an asset for longer than you intend to. For example, if a stock is still rising but its underlying fundamentals have changed, and you have taken your investment time horizon into consideration, you may not want to continue holding that asset.
FAQs
Can you sell stocks after the stock market has closed?
After-hours trading is limited in Canada. Only stocks listed on the TSX or TSX Venture Exchange and ETFs may be traded after hours (alternative exchanges in Canada are excluded). To trade after hours (the market is open from 9:30 a.m. to 4 p.m. ET), orders must be submitted between 4:15 p.m. and 5 p.m. ET on that day. Only limit-orders qualify, priced at the last price the security traded for that day. Also, only standard board lots – bundles of 100 shares – are eligible. The procedure is quite similar to trading during regular hours except that instead of placing a market order, you will have to place a limit order.
Strategies to determine price targets to sell securities
Determining a price point for the sale of an asset can be established on a variety of factors. For example, an investor who uses fundamental analysis may look for a target price-to-earnings ratio. Investors using technical analysis might base their decision according to a particular trading pattern. Understanding your risk tolerance may also play a part in determining your selling parameters.
Are there times when investors should avoid selling stocks?
During periods of intense market volatility, some investors might consider whether to avoid making larger moves. Examples of this can happen when a particularly sharp dip is followed by a rebound. Those who might have sold could crystalize losses and also miss any ensuing rebound.
Should investors ever sell stocks at a loss?
Selling a stock at a loss may feel counterintuitive, but it could be a consideration, for example, if something fundamental has changed about the company, such as its management or outlook. There may also be cases where an investor might choose to sell assets in the interest of balancing the stock and bond allocation in a portfolio.
Conclusion
An exit strategy can help you achieve your financial goals by reducing the emotional component of investing and allowing you to think rationally during times of market uncertainty. Stop-loss, stop-limit and take-profit orders may each be an effective way to automate the on-going process of managing your investments.
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