As a long-term investor, you have probably braced yourself for temporary declines in the value of your portfolio. However, there is always a risk that the price of a stock you own falls more than you can stomach; or that you cling too long to a rising stock, only to see it fall. To deal with those situations, you need to have a plan as to when and how to dispose of such assets - this is called an exit strategy. In this section, we’ll give you a broad overview of possible strategies, plus a few tips on how you can execute them at specific brokerages.
What is an exit strategy?
An exit strategy is a set of guidelines you create for yourself that outline the specific circumstances under which you would sell an asset (a stock, ETF, bond, etc), as well as being aware of the practical side of how you can sell these assets. Exit strategies are relevant in many areas of life (including for business owners/founders and for investors in private companies), but here we’ll focus on exit strategies for long-term equity investors.
So what’s the use of having an exit strategy? Here are some benefits and pitfalls you need to be aware of as you consider crafting your own exit strategy.
It provides structure and discipline to your decision making
It helps you minimize psychological bias and rule out emotional decisions
It gives you specific benchmarks by which to assess the current state of an asset or your entire portfolio
Setting too-strict exit rules might result in a premature exit and therefore missed opportunities
Time commitment and complexity: figuring out your exit conditions and monitoring whether they are met require time and effort
Examples of exit strategies
What are some examples of exit strategies? In the context of long-term equity investment, the following are quite common:
Profit target: Setting a profit target upon buying a stock means designating a price point (or a percentage increase) above the current share price at which you will sell the stock and take a profit. Setting a profit target is a smart way to make sure you don’t pursue unrealistic gains in a risky stock that has an equal chance of posting big gains and big losses. Many brokers allow you to set an automatic order to sell at a specific price point; alternatively, you can set a price alert to be notified on your phone or in your trading platform when the stock price reaches your target.
Stop loss: A stop-loss target price is the opposite of a take-profit target price: it designates a price level beyond which you do not tolerate additional losses and at which you’d like to sell a particular stock. A lot of brokers include a “stop-loss” function in their order panels, so you can easily set a stop-loss price when buying a stock. This instructs the broker to automatically sell the stock when it falls to that price.
Trailing stop: A special case of a stop-loss order is a trailing stop order. Instead of a fixed stop-loss price, it allows you to set a stop-loss level at a specific percentage below the market price; therefore allowing it to rise in tandem with the market price. For example, setting a $20 stop-loss price for a $30 stock can make sense; but if years pass by and the stock rises to $100, that $20 stop-loss level will start to look way too low. However, if you set a trailing stop at, let’s say, 30% below the market price, the stop level will move higher along with the stock price; in our example, it will rise to a still-reasonably safe $70 when the stock price hits $100. Trailing-stop prices only ever move up; they stay in place when the stock price starts falling.
Time-based exit: In addition to a profit target, you can also set a time goal for your investment - basically, giving the stock a certain amount of time to reach a profit target. So when buying a $100 stock, instead of simply saying “I’ll sell it when it hits $120”, you can also say “I’ll sell it if it doesn’t hit $120 within a year”.
Accessing your cash when exiting
Once you’ve decided to sell a stock, it is a fairly straightforward procedure at any trustworthy broker (the only type we recommend here at BrokerChooser). Just place a simple market order to ‘Sell’, and your stocks will be sold immediately at the current market price, provided that the stock exchange where your stock is listed is open for trading (this usually means daytime hours at the exchange’s local time on weekdays).
There are just two things to keep in mind when selling a stock (whether by yourself or automatically via a stop-loss or similar order):
Your broker may charge you a commission for selling a stock - usually the same commission it charges for buying a stock.
On most exchanges, it takes about two days for stock trades to settle; that is, it takes that long for proceeds to appear in your broker account as free cash. Should you decide to withdraw this cash rather than reinvest it, it may take another day or two for the money to arrive in your bank account or card balance.
Closing your account
There may be situations when you’ll want to close your broker account altogether. Maybe you have found another broker with lower fees and a better product selection; or maybe you have achieved your investment goals and are done trading for good.
At all online brokers, it is a basic right to terminate your account; a process you can launch from within your trading platform or by contacting customer service. But before you do, take a moment to check if your broker charges an inactivity fee or regular account fee that is applicable to unused accounts. If not, you might as well keep your empty and unused account - who knows, it may come in handy again one day.
If you need to abandon or close down your current broker account, you first need to empty your account balance. If you’re switching to a new broker, it is usually possible to transfer your stocks and other assets to another broker. This can be a bit of a hassle and you’ll need help from customer service, but it is still better than having to sell and repurchase all your holdings.
How brokers can help you carry out your exit strategies
Closing your brokerage account
If a broker doesn’t charge any account or inactivity fees, you don’t necessarily need to close your account right away, even if you don’t plan to use it again. If you do decide to fold your account, the process is not always simple - especially if you need to transfer your stocks to another broker - but fast and efficient customer service can help a long way. So see below if the broker of your choice makes your life any easier when the time comes to say goodbye.
Selling a stock shouldn’t be a problem at any reliable broker, but watch the fine print to see if any trading commissions apply. And if you want to withdraw some money afterward, it’s worth checking available withdrawal methods and whether they’re all free of charge. See below what awaits you at some popular brokers.
If you want to transfer some or all of your stocks to another broker, it is now usually entirely possible. Sometimes the process is still largely manual, but those switching between US brokers can take advantage of the Automated Customer Account Transfer Service (ACATS), a centralized system for stock transfers. Either way, transfer times and costs can vary widely, so check the list below to see transfer conditions at some top brokers.
Should I use a profit target or a trailing stop for my exit strategy?
You can actually use both. You can set a profit target that is in line with your investment goals; and then set a trailing stop price so you can lock in gains in case the price starts falling.
Are there risks associated with stop-loss orders?
A possible risk is that you set your stop-loss price too close to the current price, and your stock gets sold prematurely during what may only be a temporary small dip in the price. Other risks include low liquidity (so that some of your stocks get sold at only a lower price when there aren’t enough takers at your stop-loss price); and gapping (if the stock price leapfrogs your stop-loss price when the market opens in the morning).
What are the three types of exit strategies?
Three common exit strategies used by long-term equity investors are take-profit orders, stop-loss (or trailing stop) orders, and time-based exit.
When should you exit a stock?
You should probably exit a stock when it falls so much that it threatens the overall value of your portfolio. You should also consider exiting a rising stock if it has reached what you think is a reasonable return that’s worth locking in; or conversely, if it has failed to reach such a target within a time frame you have set for yourself.