Many traders new to the game believe that if you just manage to find a good time to enter a trade, then everything else will sort itself out. Indeed, the sole focus of many traders on trading entries shows this is the case. However, using the right exit technique is just as important as getting in at the right time. Unfortunately, this is something most traders completely forget about.
So, how long should you hold a trade? You should hold a trade until your predetermined conditions to exit are in place. This could mean that you hold your trade for a period as short as a few minutes, up to several months, depending on the trading style and exact rules you are using.
In other words, you cannot give a clear answer to the question, since it will vary a lot depending on the type of exit that’s used by the strategy. With that said, in this article we will look closer at different approaches to determining the holding period, as well as some common lengths used in the most common types of trading strategies.
Common Exit Techniques
While there are endless variations as to how you can exit a trade, there are some techniques that are more common than others.
Some common exit techniques include:
Exiting a trade after a certain amount of time: This means that you already beforehand know how long the trade should last, provided that any other exit rule, such as a stop-loss, doesn’t kick in earlier.
Exiting once the market has rebounded: In mean reversion strategies we buy on a dip and wait until the market has reversed. Thus, we may use some sort of overbought signal, such as a high RSI value, to know when it’s time to get out of the trade.
It should be noted that this method, unlike the previous one, doesn’t dictate the actual time to stay in a trade. Following this, a typical holding time could become quite protracted, if the stock continues to fall.
Stop loss and profit target: This is a method where you decide beforehand the target amount, and the stop amount. The rationale goes that if the stop amount is hit, then the market has shown that it won’t pursue the target level, which we were hoping for.
In essence, this means that you exit at either a particular profit amount, or at a particular loss amount.
How to Decide What Exit Method to Use
Since there are so many different exit methods to use, you might be wondering which one you should go for yourself. Well, the answer is that you need to carry out tests yourself to see which exit method works well with your trading strategy.
To know what has worked well with your trading strategy in the past, you must learn how to backtest, which basically means that you run a historical study to see what worked and didn’t work in the market.
While you can perform backtests manually, there are many advanced software solutions that will reduce the time needed dramatically! By learning an easy coding language, such as Easylanguage, you will be able to quickly identify where the real edge lies!
Common Holding Periods for Different Trading Styles
Depending on the type of trading you do, you usually are confined to certain holding periods as per the general definitions of the trading styles themselves. And while you certainly don’t have to follow them each and every time, it’s good to know the typical holding period of different trading styles, since they inevitably bring disadvantages and advantages to your trading.
Being the most exotic and sought after trading style, day trading is a trading style where you close all positions before the end of the trading day. This comes with the benefit that you avoid the risk of suffering extended overnight gaps, which could wipe out large portions of your profit. Considering that the average trade of most daytrading system is quite small, it might appear like a smart move to avoid this risk altogether.
However, what is forgotten in this reasoning is that nearly all returns in the stock market for more than 20 years have come in the form of the so often dreaded overnight gap. So in effect, by avoiding the risk of having the market gap against you, you also remove a lot of the profit potential.
This brings us to the next trading style, which is swing trading.
Swing Trading is a trading style where you attempt to catch the medium-term moves in the market that may last for one day up to a couple of weeks at most. Here we make use of the fact that most of the market’s gains actually appear during the night.
Since we hold on to positions for longer periods of time, it also means that the average trade tends to get higher, which makes us less susceptible to slippage and commission.
Position traders hold on to their positions for at least a couple of weeks, up to as much as a few years. This trading style usually makes use of fundamental analysis to a greater degree than the quicker trading styles. The reason for this is quite logical. The markets tend to act quite irrationally in the shorter term, but the more long-term your outlook is, the more you can expect that the market will succeed to create a somewhat rational valuation of the security.
Buy and hold
Buy and hold might be the least attractive solution for traders since it lacks the glamour and allure of, for instance, day trading. However, it’s an excellent way to grow wealth, riding the wave of new innovations and growing profits in the economy.
The holding period depends on a variety of factors, and there is no way to pick a period that applies to every trader. You need to consider the strategy you are trading, as well as the objectives with your trading before you can come up with a good estimate.
We recommend that you turn to backtesting to find out what holding periods suits your strategy best.