The current futures marketplace is a dynamic environment, featuring substantial and rapid swings in asset pricing. Traders often make the choice to exit a profitable trade on an extremely compressed timeline under unstable market conditions. The ability to make split-second decisions with consistency separates successful traders from the rest of the pack.
Although traders have a vast array of philosophies and approaches to closing out winning trades, there are only two primary reasons for exiting a winner:
- when a trader achieves a predetermined profit target
- when a trader observes confirmation of changing market conditions
Profit targets are a common method of exiting a trade in positive territory. A profit target is a predetermined price where the potential capital gain justifies the assumed risk.
Developing the optimal profit target for a given trade can be a considerable undertaking, with several concerns that need to be addressed:
- Risk vs. Reward: Identifying an acceptable risk-versus-reward scenario is an integral part of setting profit targets. In futures, assumed risk varies according to contract specifications and the degree of volatility present in the market being traded. Traders use risk-versus-reward ratios (RRR) for a trade’s capital allocation, with most RRRs aspiring to realize a return on risk in excess of 1:1. Although the utility of a RRR is frequently debated within trading circles, they remain a popular method of determining profit targets.
- Trading Methodology: Trading style is a critical part of profit target development. If a trader is scalping liquid futures contracts using a short time horizon, profit targets will be much tighter than practitioners of a swing or day-trading approach. Ultimately, market exit depends on the style and methodology of the trading operation.
- Support and Resistance Levels: Traders may use technical analysis or fundamental analysis — or a convergence of both — to determine optimal profit targets. Fibonacci extensions, Bollinger Bands, pivot points and moving averages are a few tools that traders use to identify areas of support and resistance.
Exiting the market according to a predetermined profit target is a sound method of realizing profitability. Implementing targets can contribute to consistent trading practices and be a vital element of a comprehensive trading plan.
Evolving Market Conditions
In contrast to the implementation of a concrete profit target, evaluating market behavior on the fly is a much more subjective exercise. Many factors contribute to the potential for an extended or truncated move in price and the eventual profitability of a trade:
- Momentum: Traders use technical tools known as oscillators to gauge the strength and sustainability of a move in price. A few of the most popular oscillators are the Relative Strength Index (RSI), Stochastics, Moving Average Convergence/Divergence (MACD) and the Commodity Channel Index (CCI). The applications of each type of indicator vary, but the idea behind them is to quantify pricing momentum and determine whether a market is overbought or oversold.
- Market State: The price action exhibited by a specific market can provide clues on when to exit a profitable trade. For instance, if a market is trending in favor of an open position, then the choice to forego a profit target may be warranted. However, if price action looks to be entering a compressional or consolidation phase, immediately taking available profits may be the best course of action.
- Time of Day: Depending upon the market and style of trading, time of day may be an important factor in a trade’s exit. Many futures markets and contracts are prone to heightened volatility during certain periods over the course of a trading session. For example, contracts for West Texas Intermediate Crude Oil (CL) are actively traded from 9:00 a.m. to 2:30 p.m. EST. In the event that a trade is performing well, it may be a good idea to exit before periods of possible diminished participation.
Making the Decision to Exit
Perhaps the most challenging aspect of futures trading is the act of closing out a positive position. The decision of whether or not to pass up an available profit and let a winning trade “run” is one that every trader faces periodically. Whether you implement concrete profit targets or rely on intuition to provide cues for your market exits, consistency is the key. Achieving longevity in the marketplace requires practicing sound judgment while avoiding the many pitfalls of futures trading.