There are only two steps involved in stock trading: Buying and selling. Those are the easy parts. What’s difficult is knowing exactly when to do them.
Your stock entry point and exit strategy need to be aligned to maximize the profit potential. Here are a few approaches to think about when deciding when to jump in and jump off.
Calculating Entry Points
A trade doesn’t start until you enter into a position. You buy shares in a certain security, keep an eye on it, and hopefully see it gain in value. When the stock price gets to a comfortable profit margin, you either sell your shares and bank the profits or hold on in hopes prices will rise even further.
Many passive investors, the ones who favor a long-term “buy and hold” strategy, don’t worry too much about finding a decent entry point. Many of them simply buy on-the-spot at going market prices without too much technical analysis.
With short-term, active traders, it’s more complex. They’re looking to cash in relatively quickly, selling their shares to earn instant profits. So they have to be a little more strategic and nuanced about finding the right entry point.
Pullbacks, Support, and Resistance
Looking at a stock’s recent share price history gives you an idea of where it’s trending. When you’re searching for an entry point, you’re looking for a spot that indicates momentum is going up but hasn’t hit its peak yet. You can probably get an idea of this just by looking at the price history, noticing consecutive periods of consistent growth. But a more reliable, easier approach is to look at the stock’s moving average (MA).
The MA is a calculation of a stock’s average price over a given number of time units: 10, 20, 100, and 200 days are especially popular. Your online brokerage stock charts should be easily customized to display the MA you wish (if they aren’t, think about finding another brokerage).
You’ll see the stock prices as they relate to the moving average. If you’ve found an up-trending stock for which prices are outperforming the MA, look for an occasion when they go down in price closer to the line of the MA, or even go below it. This is called a “pullback.” It’s a simple downward correction before prices go back up again — in other words, an entry point.
Upward trending price lines, especially MA’s, are indications of “support” in the marketplace. Even if the prices dip a little bit from day-to-day, if they don’t fall too far too long, there will still be support. The opposite of this is “resistance,” which would indicate a possible exit indicator. As long as support levels remain solid, it’s probably a good time to jump in.
Another way to calculate an entry point is to look at how many people are trading in the stock at the moment. When there’s a lot of volume and the stock price is going up, that’s as close as you can get to a confirmed bull market for the stock. It may be time to enter into a position before the profit margin disappears.
Of course, high volume accompanied by a declining stock price means people are selling their shares in the droves. Especially if you’ve earned a profit from the stock in this situation, it’s likely time to cash out.
Crossover with Two Moving Averages
An especially popular method for determining entry and exit points is monitoring two different sets of moving averages — say a 20-day MA, and a 100-MA — and executing on positions when the shorter-term MA crosses the longer one.
The longer MA indicates a more stable pattern; typically, its rises and falls are very mild. The shorter MA is slightly more subject to volatility. Investors believe that when an upwardly moving shorter MA crosses over the trajectory of the longer one, it’s a sign to enter into the position.
Conversely, when the shorter MA crosses downward and goes south of the longer MA, it’s time to exit.
One chart event that investors watch out for, especially in intra-day trading, is a continuation pattern. This is a series of up-and-down price movements immediately following a big vertical movement. They’re used to time entry — and occasionally exits — from a stock position in anticipation of an eventual return to the trajectory.
For example, say a stock emerges from a long flat or downward trend with a sudden jump in buying volume and price at the end of a stock market day. The next morning the stock recedes a little bit, then bumps up mildly, then drops a bit, then goes back up a bit, and maybe goes through the cycle another time or two. This resolve of the stock price is called “consolidation.”
Now, you could enter into this stock at some point on the original way up. But you can’t be sure that upward trend will continue — and in fact, it doesn’t. You’d prefer to wait out the consolation period until you see signs of continued, sustained momentum.
That’s the basis of a continuation pattern. Two of the most commonly known patterns are the “flag” and “pennant.” The initial stock price jump resembles a flagpole. If you were to draw two lines on top and below the consolidation period, it would look like a flag, or potentially a pennant if the variances are narrower.
If, after consolidation, the stock price eventually crosses the top line of the flag — or the nose of the pennant — it may indicate a great time to enter into the stock. It’s survived a brief period of investor settlement and appears to be headed toward a sustained period of growth.
Flag and pennant patterns also work in reverse. If a stock endures a steep vertical drop, there may be a period of consolidation where trading goes up and down. In this scenario, if the stock price drops below the bottom line of the “flag,” it’d be time to exit.
There’s no guarantee that continuation patterns will always play out. But especially for finding entry points in bullish stocks, flags and pennants are uncommonly effective.
Calculating Exit Points
Exit strategies can be tricky. Buy-and-hold investors naturally want to hang on to their shares for as long as possible in hopes that they’ll continue to ascend. Day and swing traders make more frequent transactions, hoping to cash in on more modest price movements just before they stabilize or drop off.
In a lot of ways, calculating a stock exit point is an entry calculation in reverse. You see a downward trend occurring and look for temporary price increases to get out of before the decline becomes long-term. You use bearish flag and pennant patterns to determine the best time to close a position.
But figuring out an exit point is more complex than buying into a stock. Most investment experts strongly advise setting an exit plan as far enough in advance as one can.
What kind of trader you are will dictate a lot about what exit strategy you’ll employ. But it’s a good idea to set a limit order for certain commodities, so you can take profits and keep your investments more liquid.
A limit order is simply a direction to your brokerage to sell your stock after it reaches a certain higher price point. If you buy 5 shares at $100, you might set a limit order to sell all of them as soon as the stock price hits $200. If and when it does, your brokerage turns your limit order to a market order and returns the profit to your account. You’ve made $500.
There’s no real tried-and-true method for calculating the right point for a limit order since the majority of stocks on the market appreciate over time.
A stop-loss order works just like a limit order, but for stocks that are headed for a loss. You direct your brokerage to sell your shares after they’ve declined to a certain point, so you can cut your losses.
Every position you own should have a stop-loss order attached to it, even the value stocks. It’s a form of protection against drastic losses. If you’ve invested in a position at $50, you might decide to set a stop-loss order when it declines by $10 or 20% of the value.
With more expensive, value stocks, you may set narrower stop-loss limits — 5%, for example. A typical strategy is to keep raising your stop-loss limits on stocks that are consistently rising in value. Once the stop-loss limit passes your entry price, you’ve guaranteed that no matter when the sale executes, you’ll break even. Continuing to raise your stop-loss limit as the price goes up guarantees you’ll turn a profit when it sells.
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