What is an Exit Point?
A trade involves buying and selling an asset to make a profit from the difference in the market price. Therefore, it is important to understand and decide when to buy or sell an asset.
An exit point is a price at which an investor closes their position. Usually, the investor sells the asset at the exit point to close their position. However, if the investor is short, they may buy at an exit point to close their position. For example, if Anil buys a share at ₹400 and after a month the market price of the share becomes ₹450. So, Anil decides to sell his share at this price and ₹450 becomes the exit point for this trade.
The exit point is often decided beforehand and depends on the investor’s or trader’s strategy. Sometimes, the trader might need to change the exit point according to real-time market conditions. For example, if the market is going to dip, the trader might want to sell earlier than the predetermined date. In such cases, the exit point can vary.
An exit point is initiated through an order. When the order is sent out, it can result in the investor gaining profit or incurring loss depending on the direction in which the market price has moved.
Advantages of exit points
Exit points are used to manage the maximum profit and loss potential of a trade. By setting these exit points beforehand, the investor creates a safety net in case the market price movement is unfavorable. For example, Smiti has bought a share for ₹540, and the market price of the share falls. By setting an exit point at ₹480, Smiti can limit the amount of loss, i.e. ₹460, that the trade can incur.
When an investor sets the profit target, a predetermined exit point ensures that the share is encashed as soon as that price reaches. This means that the further fluctuations do not affect the investor’s profit.
A real-world example of an exit point in the Stock Market
An exit point can be applied by a trader whether he’s placing a long or a short position. Let’s consider a trader who has placed a short position in a falling stock.
This scenario could have been possible with the previous quarter of HERO MOTO CORP LTD. As the stock broke below a rising trendline and entered into a downtrend, the trader could have jumped into a short position on the 19th of October at Rs. 2890. The stop-loss (stop market order) could be placed at Rs. 2949, which is just above the recent swing high, if the price went up instead of down.
Since the trader expects the price to fall, he could place a target order at Rs. 2775, below the previous swing low.
The risk/reward relationship created by this type of trade is rather favorable as the trader is risking Rs. 59/share (2949 - 2890) while expecting to make Rs. 115/share (2890 – 2775).
Types of exit point Orders
An exit point order set at the profit target is called a limit order. It is because this exit point order limits the maximum profit that can be earned. If the investor is bullish, the limit order is set above the market price. When the market price reaches that amount, the order is automatically filled and the share is sold at that price. These orders allow the investor to exit the trade with a planned profit.
Similarly, a stop-loss order is set to limit the maximum loss that can be incurred. If the investor is bearish, the stop-loss order is set below the current market price. This exit point order ensures that if the market price starts declining, the share is sold at the set exit point and the loss is limited.
To exit their investment at any moment, the investor can simply issue a regular market order. Alternatively, they might use a trailing stop-loss order to join while the price is going in their favor but exit when it begins to move against them.
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Frequently Asked Questions
Exit points with bracketed orders have a combination of profit target and stop-loss exit points. The investor buys security and selects a profit target to place an exit point order. Simultaneously, a stop-loss order is placed at a specified price to limit risk.
This creates a range for the investor with a maximum profit, a break-even point, and a maximum loss. It is a good strategy to reduce the risk involved in the trade. The longer the term of the investment, the farther away the exit point orders are. If the stop loss and profit target are close to the entry point, the trade can close fairly quickly if any order is hit.
Identifying entry and exit points requires analysis of the market conditions and also depends on the investor’s risk tolerance. Sometimes, fundamental analysis is enough to make this decision. Investors can decide at which price to earnings ratio they want to close their position and select an exit point accordingly. In the case of day trading, they can base this decision on the trends and reversal patterns.
Other simplistic methods like deciding a target profit or target rise in price are also used. For example, an investor selects an exit point where the profit from the trade is ₹500 or when the price has risen by 20%.