One of the most important questions that must be answered by the trader when a position is entered is, when do you sell or close out the trade? It is very important for the trader to set a target exit point for each trade. A target exit point is a stock or option price that would result in a realistic profit.

By setting profit objectives in advance and determining the target exit point before the trade helps avoid the consequences of one of the major stumbling blocks to achieving trading profits, which is greed. It is very hard for most traders to set reasonable profit goals once an option or stock has jumped substantially in price. That extra point becomes a moving target with each advance in the price. Therefore, it is not surprising that a reasonable profit is not achieved when the trader is forced to bail out because of tumbling prices.

Although setting profit goals in advance may be simplistic and not the most flexible approach to trading, the target exit point approach to taking profits is a necessary compromise especially for the trader who has neither the savvy nor the emotional control to know when to hold and when to fold in the heat of battle, and who is also unable to stay tuned to the markets throughout the trading day.

Note also that the profit objective should be substantial, meaning at least 100 percent, or double your initial investment, so you will not be walking away with small profits by using this approach. With this approach, you will miss out on those 1,000 percent gains that are the equivalent of hitting the jackpot—but what is much more important is that you will minimize the instances of solid profits becoming painful losses and you will regularly be taking respectable gains off the table.

Once the trader has entered the heat of battle, the tendency will be to base decisions upon emotion, and therefore those decisions will tend to be incorrect. To avoid this pitfall, set a closeout date based on the amount of time expected for the position to reach its target exit point. If that profit level has not been reached by the closeout date, exit the position on that date. For option trades in particular closeout dates should be set so that there is still enough time until expiration to salvage some time value from the option if the underlying stock has failed to move.

The trader should resist the temptation to sell at a small loss prior to the closeout date. That would be yielding to fear, robbing the trader of some potential gains. Also, the trader should resist the temptation to raise the profit objective as the price nears the target exit point. This would be yielding to greed, and profits will slip away.

Another important question that needs to be addressed is, when should the trader sell? The trader should not sell a position the instant it moves against them. There is never a need to engage in panic selling if it is assumed that the original conditions for opening the position still hold true. Also, the trader needs to make sure that they are not committing an excess amount of trading capital and that they are still operating within their own risk tolerance.

As traders we create positions for their huge profit potential, which can be fully realized only by allowing positions to remain open for a reasonable period of time. Setting predefined exit points goes a long way in facilitating this task.

Happy Trading.

Jeff Neal 
Senior Writer, Options Strategist & Profit Strategies Radio Show Market Correspondent
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