How to determine entry and exit targets when investing in the markets?

Identifying great investment opportunities in the markets is great, but investors should be aware that the price at which a position is opened can largely determine how profitable that investmentcan be over time.

For this reason, determining which are the most adequate price levels to enter and exit a certain investment in the financial markets can be advantageous to increase the potential profitability of a position or cut losses before they eat up a significant portion of your capital.

In the following article, we will explain how you can use some technical and fundamental indicators to determine potential entry and exit targets for your investments to further polish your investment and risk management system.

Using technical analysts to identify entry and exit targets

Technical setups are used by professionals to determine potential entry and exit prices for a particular instrument based on the fluctuation in the price, demand, supply, and performance of that particular asset over time.

One of the most common ways to determine these entry and exit levels is by using support and resistance patterns, which indicate price levels at which market players have responded either by pushing the price higher or by selling off the instrument – dropping its price as a result.

The chart above shows how the price of gold has fluctuated within a certain range in the past few months, finding resistance at the $1,960 level – a price that bulls have struggled to clear – and support at the $1,850 level – a price at which bears have found strong demand, which has ended up pushing the price higher once the level is touched.

Using these markers, traders can open a long position by using the support level as the entry price and the resistance level as the exit target. Meanwhile, a stop loss order – which is a risk management tool – can be set at a price below the support line, say at $1,830 or $1,800 depending on the trader’s maximum loss permitted.

Other technical tools that can also be used to determine potential entry and exit prices include:

Meanwhile, there are also certain indicators that can trigger buy or sell signals, as is the case of the Relative Strength Index (RSI) and the MACD oscillator, both of which use moving averages to determine if the price of the instrument is seeing positive or negative momentum based on its latest trend.

Fundamental analysis can also be used for this purpose

Fundamental analysis, which consists of analyzing a company’s financial information to come up with a valuation for its stock, can also be used to determine potential entry and exit levels for a particular investment.

One of the most popular way to do this is by using valuation multiples such as the price-to-sales, price-to-earnings, or price-to-cash-flow ratios, which can be tracked to assess if a stock is under or overvalued based on the relationship between the price of its stock and the firm’s revenue or earning generation capacity.

For example, some investors evaluate the historical trend of a firm’s price-to-earnings ratio to determine when the stock might be “cheap” relative to its historical performance.

As a hypothetical example, let’s say XYZ stock has traded in a range between 15 to 25 times its earnings over the past 10 years and suddenly certain negative news have plunged the price of the stock, resulting in a temporarily depressed price-to-earnings ratio of 10.

This lower-than-average multiple, all things being equal, can be taken as a plausible entry level, especially if the news don’t materially affect the company’s fundamentals such as its earning-generation capacity.

Meanwhile, a stock can also be sold if its valuation metrics seem heavily stretched, as the price could end up reversing if the market’s overly optimistic expectations are not met in the future.

Let’s say ABC’s stock (shown in the chart above) suddenly surges past its 40 all-time-high price-to-earnings multiple amid some positive news. If the news don’t necessarily change the outlook of the company’s financials, the market could be overreacting to the development and this could be a perfect opportunity for the investor to exit his position at a highly attractive price.

Bottom line

As shown above, both traders and investors can use technical and fundamental signals to come up with potential entry and exit prices for their operations in the financial markets.

The systematic use of these signals, instead of randomly trading instruments without an objective basis to do so, will usually improve the performance of a portfolio over time.