A clear exit strategy is a fundamental rule in stock trading — one that is often overlooked by many private investors. A well-defined exit strategy will guide you into a profit or minimal loss out of a stock/share.

If that’s the case, why do so many people fail to create a solid exit plan? It’s because we’re only human and our emotions often take over. The classic diseases many traders face are greed and fear. Of course you want your stock to do well, but more often than you expect the tide will turn against you. What do you do then?

Having a clear picture in your mind of how much loss you are prepared to take on a stock is a good start. Should it be -10%, -20% or -30%? That’s your decision, but make sure you stick to the guideline you’ve set for yourself and take your money out when it’s time to do so. Yes, you will be battle scarred taking a loss, but even the big players suffer losses (and suffer them often). In our current climate of economic crisis having a good exit plan is more important than ever.

A few days ago I was listening to BBC Radio 5 as I headed into the office. The story was about a guy who’d purchased £250,000 (approximately 33,333 shares) worth of Halifax Bank of Scotland on the London Stock exchange at £7.50 each. Then, the mighty credit crunch crisis exploded. He kept holding on to the stock, hoping it would go up again. As you guessed, it didn’t, and now his shares are only worth £0.70p. He took a tenfold loss. This is a perfect example of someone who didn’t have a clear exit strategy and has paid the price — literally. A clear exit strategy would have been to get a grip on his fear and duck out with only a 10% or 30% loss.

What would you have done in that situation? Hoped the stock would have gone up at £6.50 or at £4.50 or maybe at £1.50 (by £1.50 you’d be praying!). Everyone will take losses on their shares at some point but how much you lose is partially under your control and can be minimized.

Set a sensible target. For example, if a stock drops by 25% of its purchase price, sell it. Do you have a similarly clear and concise exit plan for when the market turns against you?

The same strategy can be applied even when you are making a profit from a stock. If a stock goes upwards you can lock in your profits. If you have a stock that has gone up by 70% and there’s still potential growth then consider putting in a 50% stop loss if the market turns so that your profits are protected.

A few years ago (2005) I brought heavily into mining/oil gas shares. One of them was LSE:AIM Victoria Oil Gas at 52p and it went up to £2 (happy days!). I doubled my £4500 portfolio within 6 months. I was chuffed and thought that it couldn’t end, but the end came too soon. My 100% profit then slid to 90%. I thought the market was having a glitch and it would go back up, but then my portfolio went down further. It dropped down to 80% and then to 60%.

I maintained hope that the market would go up and even took up praying to God. It didn’t work, and I’m not the religious type. Slowly, my profits started to slip through my fingers. Eventually I took a stern approach when I finally realized the market was not going to go back up anytime soon. I took my profits at 40% and ran to the hills!

Once again my emotions and undefined exit strategy prevented me from taking an 80%-90% profit from my portfolio.

I hope you can see that it’s crucial to have a well thought-out exit strategy whether your stock is flourishing or failing, and especially considering the market volatility we’re seeing today. Make sure you know which exits to take for financial success. Don’t let yourself be a rabbit caught in the headlights.

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