Exit strategy: why is so important?

Basic question: what is the goal of your investment?

Before asking when to exit and how to set up one’s exit strategy, we need to understand what goal we are pursuing. Let’s quickly analyze the three main operating modes to understand more.

Trading

By trading we will want to make profits directly in currency (probably euros).

We may decide to trade crypto assets of various kinds (from bitcoin to the last of the meme coins), but also stocks, commodities and so on. This is because we will not have an interest in holding a particular asset in the portfolio, but will just want to benefit from market movements.

Trading is entirely focused on the chart: if there is an opportunity we will not look at the asset’s face and take advantage of it.

Investment

And here we come toinvesting, which instead aims to buy assets that we are interested in, to hold in the medium and long term.

In this scenario the chart still matters, but it will be the use cases, prospects and potential that will determine whether a given asset will be right for us. In short, it is all about fundamental analysis, while in trading technical analysis is central .

Investing involves having all the excess capital we have “go to work” for us, while also protecting against inflation. Choosing which cryptos (and other products) to hold is key.

Gambling

The last operational strategy is gambling, although calling it such is very far-fetched.

In this case, we allocate an amount on an asset (usually a very volatile crypto) hoping that it will grow so much in value, possibly in a short time. At the same time, we must be aware that the invested capital is even more at risk than usual.

Recalling the comparison used in the video, betting on a crypto is like buying a lottery ticket: if it goes right, you win a lot of money; if it goes wrong, you will have lost the cost of the ticket.

Now that we have mentioned the most common operations, let’s delve into the first two.

"Trading, investment or gambling? The goal determines the exit strategy!"

Trading and exit strategy

In all honesty, we should not even talk about exit strategy in trading. This is because it is an operation that already at the opening of a position should also have the closing well defined, as everything has to be decided beforehand. And in this case the closing is part of the position itself, not a strategy introduced by “if” and “then.”

Closing is not only given by the achievement of a price target. In fact, we might set it upon the arrival of a given signal from an indicator, or upon the occurrence of a pattern. In any case, if we do not improvise, closings (both positive and negative) are set before we even open the position.

Juxtaposing “exit strategy” and “trading” is not so simple: it depends on the approach of the individual investor, as well as the position.

A few notes on trading that we should remember:

• The trader in no way predicts the future, but does a careful job of analysis and calculation;
• The trader’s goal is to have a statistical advantage over a large number of positions. Basically, we need to achieve a certain goal that makes trading profitable;
• Impossible to have certainty, there are no magic signals of any kind. Therefore, we are wary of those who promote foolproof methods: unfortunately, it is not possible;
• You have to accept that you will be wrong, that is part of the game;
• The individual position, well yes, is in many ways a gamble, however calculated and reasoned.

Investiment and exit strategy

In contrast to trading, in investing one aims not to hold cash or take profits in fiat currencies. The primary goal is to avoid capital erosion given by inflation, building one’s wealth over time.

The central element of this mode of operation is the portfolio, which will be composed of various assets to diversify and mitigate risk as much as possible. These assets will be determined based on certain elements, first and foremost one’s risk tolerance.

Fundamental then is to have one’s own investment thesis. Basically, we will have to ask ourselves two questions:

• Why do I want to invest? And here a whole series of answers open up that only the individual concerned can work out;
• Why do I want to invest in certain assets? Following on from the previous question, we go into a little more operational detail, deciding what can help us achieve our goals.

Exit strategy: why do I want to sell?

The questions are not over, because now we ask a key one on the topic of exit strategy: why do I want to sell? If we think about it, why should we exit if we think the assets in the portfolio will perform well in the long run?

Very frequently we make the mistake of confusing trading and investing. In the former it is essential to sell when a given event occurs, while in the latter it is not. If the idea is to build wealth over time by investing in assets that we think are valuable, it would not make sense to sell.

Beware, however, because there are cases in which an investor can sell; indeed, in some situations he or she must sell. These cases can be identified by correctly answering the question that gives this section its title: why do I want to sell?

Examples of answers that would justify exit include:

• Hyper-extension of the chart of a particular asset. If we notice that Ether is performing too well and expect a (sustained and heavy) retracement, it might make sense to liquidate all or part of the position, so as to protect at least a slice of the profit made; nothing wrong with that: assets don’t marry and we don’t have to get attached!
• Change investment thesis. In this case we may no longer have an interest in a given asset because the original conditions have changed. So it would be correct to close the position, either partially or totally depending on the specific situation.
• Need for liquidity. Certainly, we should have a cushion available to protect us from unforeseen events; however, sometimes life puts us in front of particular events that impose high expenses to be met. In such cases, one may opt to exit the investment, even though this may mean nullifying it in part, totally, or even closing at a loss.

Other reasons that might prompt an exit from the positions: starting one’s own business (business is also an investment), sensational deals on which one must take advantage, other investments…

Having reached this point, we can consider some exit strategies.

Go short!

The hedging short is a simple solution, suitable only for situations where we think there is a possibility of a retracement.

The concept is to hold the spot asset, opening a short position, then of the opposite sign. The goal is not to speculate, but to reduce losses should a long bear market occur.

Clearly, it is necessary to establish this type of exit strategy well.

First of all, we will need to place a stop loss that goes to automatically close the short in case we were wrong. In this way we will protect ourselves and contain the losses.

We will also have to determine what the target is in case indeed there is a retracement. In fact, we will not be able to keep the short open indefinitely, but there will have to be a definite target to be reached. To do this there are a variety of methods available (price levels, events on indicators, pattern making…) and remember: there is no such thing as a perfect signal.

In fact, short covering is a trading position that goes against the long-term trend we expect. The outcome is obviously uncertain.

Before opening a short one must ask an important question: why should I open a short position? Trivializing and thinking things like “the asset is in All-time High, so I open the short to protect myself” is wrong, just as it would be wrong to close the position directly. Instead, one needs to make one’s own assessments and reason with the long term in mind, because that is what investing is all about.

Covered call

Options come into play in this exit strategy, a complex instrument that only those with some experience should use.

The idea is to employ call options on the same instrument that you hold spot (e.g., options on Tesla stock while you actually own this stock).

The covered call is intended to protect us from a possible retracement. Note well that you do not protect yourself 100% from losses, but contain them to a variable portion.

Given the operational complexity, we encourage you to read our article on options.

"Covered call is a possible strategy, but watch out for complexity"

Portfolio rebalancing

Portfolio rebalancing is an excellent exit strategy with minimal emotional, time and variability impact. In addition, it is also quite simple to implement.

The operation is suggested by the name itself: we rebalance the assets in the portfolio, bringing them back to the initial balance we set for ourselves. For example, let’s imagine we have these proportions:

• 25% in BTC
• 25% stocks
• 50% in cash and bonds

If BTC went up a lot in price, these proportions would no longer be met. We would then have to sell the crypto and buy the other assets, so as to return to the correct proportions. Reverse discussion in case of a loss.
Tip: Establishing a certain tolerance is a good way to avoid continuing rebalancing; we could, for example, decide not to move until the changes reach -/+ 5%.

The main advantage of rebalancing, in addition to simplicity, lies in the mitigation of the average loading price. After all, one follows the rule of “buy when it goes down, sell when it goes up,” thus lowering the PMC.

The con is the possibility of running into lost profits. If we rebalance an asset because it has gained so much value, in the event it continues to go up we will realize a smaller profit. There is little we can do about it: this eventuality is also part of the game; we have to accept it.

Complete cash out

In this scenario you get to sell everything in one go , disinvesting.

Total cash out only makes sense if you have no choice and liquidity is needed. If we believe in an asset and think it will appreciate in the long run, it would be very risky to sell everything without the need to do so: if the value were to go up we would have literally shot ourselves in the foot.

Another eventuality that justifies complete cash out is wanting to disinvest from that particular asset, or from one or more asset classes. If the investment thesis has changed, it is right to close everything out and respect the new decisions made.

The ideal time to cash out is near the highs, but you may not necessarily find yourself in exactly that situation. Plus, who knows where the price will go-it could go up again!

Last but not least: cash out is a taxable event. Let’s think carefully before proceeding.

Let’s move on to the last exit strategy, closely related to the one we have just seen.

Cash out DCA

The DCA cashout consists of disinvestment in installments, not in one lump sum. Thus, the time variable is significantly scaled down.

It would be preferable to start the procedure near the highs, so as to achieve higher gains.

In any case, for everything else we end up with the same problems as with the total cashout:

• The event is taxable
• We are back on fiat currency, with all the relevant issues related to value erosion

When in doubt, we should always ask ourselves why we want to cashout. If the answer is “I’m afraid it’s going to retrace ” or something like that, let’s remember that we have other tools available such as options or shorting, as well as portfolio rebalancing (simple and suitable for almost anyone).

We thus close this in-depth study, which we hope will help you make more informed and efficient decisions. Thank you for reading us!