Most new traders are focused on finding entry signals for their trades. They spend time studying indicators and technical patterns, looking to create combinations that lead to “high probability” entry points. After finding reasonable setups, many traders stop their research and start placing trades, ignoring the question of where to exit.
If they become dissatisfied with how their trades turn out, they might review any number of popular trading books, which will inform them to “let your profits run and limit your losses.” The idea is to capture the occasional big winners that will more than make up for a larger number of small losses. However, a profitable trade will often turn into a loss, leaving traders wishing they had exited earlier. After suffering through a few such trades, conflicts can start to form in the trader’s mind that lead to second-guessing and other psychological pitfalls that hinder trading.
The solution is to research exit strategies to the same degree as entry setups. With the addition of sound exit strategies, trading reaches a point where it is more about following procedures and less about moment-to-moment judgment. One way to determine exit points is to walk through trades individually and analyze maximum favorable excursion (MFE) and maximum adverse excursion (MAE) statistics. This analysis can be applied to both historical back-tests and to track real time trades.
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