A trading exit strategy is one of most important, yet least understood components of options trading. In this lesson you'll learn how to protect and keep your options trading profits.
In this lesson we will cover Steps 6 & 7 of the seven step trading process: Exit Strategy and Money Management
It's actually easy to make money. The hard part is keeping it. Your exit strategy and money management rules are what you'll use to manage the risk of options trading.
Options trading involves far too many variables beyond your control. You must have a trading exit strategy planned out before you enter a trade.
It's an easy way to manage risk.
As you are aware from the paper trading options lesson, I entered an option trade on the stock "INFY" (Infosys Technologies).
As of this writing, I am still in the trade. The stock is trading at $49.29 and the price of the option contract is now trading for $6.80, which gives me a current return on our investment of 100%.
I exited the trade at a price of $5.60. This puts the return on investment at 65%. It's not the 100% I once had, but I am perfectly fine with 65%.
This is also very common. If you wait for a technical exit you will often give up some of your gains. If my profit target was 100% then I would have exited the trade once that target was met.
The reason you plan your exit strategy before you enter a trade is because once you are in a trade, your emotions will cloud your judgment.
Every investor should have an exit strategy.
There are primarily two things you will consider when you are creating a trading exit strategy:
If things go wrong
Stock options are extremely volatile. It's not uncommon to see your trade fluctuate in value by 10-20% during the trading day.
Once I place my trade, I will instruct my broker (via a hard stop) to close out my trade if it drops in value by a certain percentage.
If I lose 30-50% of my invested capital, I cut my losses and I move on. That's enough of a loss to tell me that either this is a bad trade or I was wrong on my timing.
Either way, I was wrong.
Learn to swallow your pride and pay attention to the feedback your trade gives you. There is no reason you should lose all of your money in a trade.
If things go right
Once my trade has gained value by 30-50% I begin to look into either protecting my profits or at least ensuring that I will not lose money on the trade.
I will either place a hard stop at my entry price or set a trailing stop. This is more of an art than a science. Each stock and each trade is different so it takes time to learn how to properly set stops.
There are plenty of books, courses, friends, and news commentators who are more than willing to advise you on getting into trades, but where are they when you need to get out?
Nearly everyone knows how to get into trades. It's the knowing when to get out part that eludes people.
Here are 3 simple methods to use as a trading exit strategy:
If you have poor money management habits, then you will not survive as an options trader. Poor money management habits are also why some people succeed in life financially while others barely get by.
I'm not going to give you any hard fast rules to follow, just a few common sense principles that should keep you out of trouble.
No one has ever gone broke taking a profit. Remember there is no such thing as a small profit. As long as you make more money than you lose, your account will continue to grow beyond measure.
Products Created by Trader Travis
Options Trading Made Simple Course
Marketclub Options (offered via Marketclub)
Free Options Course Learning Modules
Module 1: Option Basics
Module 2: Option Value
Module 3: Basic Strategies
Module 4: Stock Charts
Module 5: Technical Indicators
Module 6: The 7-step process I use to trade stock options