Winning or losing, deciding on the exact time to close your trade can drive you nuts.
Traders spend most of their time researching setups for trade entry, using fundamental analysis, chart patterns, signals from technical indicators, or some combination of these. No I agree, there is no doubt about it, finding entries is vitally important, because the entry is the foundation upon which a trade is built. However, if finding good entries is the most difficult thing, finding good exits is the most emotionally challenging part of the trading process.Common exits occur when traders get stopped out at a stop loss level, close the trade as a stock gets extended, or at predefined targets levels.
Stops - All trades should have a stop loss in place. Some traders hold a mental stop, while others place physical stops in the market. Initially the stop is set at some level representing the maximum risk the trader is willing to bear if the market turns against the trade. Later, if the trade moves favorably, stops can be adjusted to lock in profits. Trailing their stops like this enables traders to stay with the market as long as a positive trend exists, until a trend reversal stops them out.
Stops are usually placed close to support and resistance levels apparent on the charts. Experienced traders can easily anticipate where most stops will be resting. Whenever a support or resistance level is penetrated there is often a sharp price movement as stops are triggered.
Extension - Frequently, trend moves reach a climax typified by steepening price movement on the charts AND very high volume. This is the moment when everybody is franticly trying to jump on board the trend, whatever the price, whatever the direction. Smart traders go against the crowd by closing positions into such spikes.
Price Targets - Other traders prefer to set targets for their trades. Target levels are frequently set near the next resistance level for long trades, or support level for shorts. Sometimes targets are based on a multiple of a market movement, or swing, already apparent on the charts. Other times, targets are set at a multiple of risk with no particular reference to the chart. Yet again, there are traders who look to mystical numbers (like Fibonacci) to set their exit targets.
You have probably guessed that there is no right answer here. A technique may do well in a particular set of market conditions, but bomb in others. The skill of the trader may help, although there is no evidence that a trader relying on intuitive exits fares better than one who relies on the same exit every time.
The Day Trader - As a day trader, there are certain psychological aspects to the exit which are important. A day trader can usually get into a trade quite quickly at the open. However, the exit may not come for a long time. Indeed, if no other trigger has arisen, the trade may be exited in the last few seconds of the market session. So you have to decide whether to use an exit strategy that requires you to watch every tick of market action, or choose a strategy that lets you walk away. To me, this is a no contest. I want to be liberated from watching the screen for hours on end on those days where the market goes nowhere. I also want to avoid psychological stresses as the market swings up and down. On good days, price moves directly to your target with barely a flicker. On other days, it gets there through a series of price gyrations. If you watch every move, your emotions are on a roller coaster as your paper profits expand and contract. The temptation to exit a trade early is sometimes huge. For that reason, many traders prefer to avoid techniques which require them to watch the market, such as trailing stops behind support / resistance levels, or watching for volume spikes.
Instead, many traders prefer to set a target, a stop loss, and a market order to exit at the end of the session if neither of the other two orders fires. Connect these three orders in an OCO (one cancels other) group, and you are free to enjoy your day doing whatever you wish, confident that the trade is executing perfectly according to your predefined plan.
Another variation is to set an automatic trailing stop loss of fixed size. For example, you could specify a stop trailed exactly 4 points below the session high for a long trade, or above the session low for a short. That implements the trailing stop loss approach automatically without the need to identify support / resistance levels as the session progresses. Again, the trailing stop loss order may be connected through an OCO group to a market order exiting the trade at the end of the session if nothing else has happens.
Only those with practical trading experience will really understand, but believe me, the most stressful trading hours are those spent watching each market tick. Even if you are winning, you go through the torment of seeing large paper profits severely eroded during pullbacks. (Why, oh why, did I not sell at the peak?) Sometimes, you capitulate and take a small profit while it is still on the table, only to see price turn right round and race back up to new highs.