What it means
Every trade has a beginning and an end, and the entry point is the beginning. It is not a vague hope that the price is about right; it is a defined level or signal that triggers the decision to act.
Having it written down in advance helps traders avoid acting on impulse. Traders choose entry points using various methods.
Some look at technical analysis, which studies price charts, and wait for a price to break above a resistance level or bounce from a support level. Others use fundamental analysis and buy when a company's price falls below what they believe it is worth.
The entry point works together with two other levels. A stop-loss is the price at which the trade will be closed to limit the loss, and a target is the price at which profits will be taken.
The distance between these levels determines the risk and reward of the trade, and a sensible plan looks at both before any money is committed. Position size is linked directly to the entry point.
If the gap between entry and stop-loss is large, the trader buys fewer shares so that the possible loss stays within a fixed amount of money. Many professionals risk only a small percentage of their account on each trade.
A nuance is that a good entry does not guarantee a profitable outcome, and a poor one can sometimes be rescued by good risk control. Entry points also apply outside trading, such as when a company decides at what price it would acquire a business or when a treasurer buys currency.
In every case, the discipline of defining the point in advance is what matters.
In practice
Real-world examples.
Example
A swing trader watches a share that has traded between $20 and $25 for weeks. She sets her entry point at $25.50, just above the top of the range, expecting a breakout. She places the stop-loss at $24.50 to limit the risk if the breakout fails.
Example
A long-term investor believes a manufacturer is worth $60 a share. He decides that his entry point is $48, giving a 20% margin of safety. He places a limit order and waits for several weeks until the price drops to that level.
Example
A company treasurer needs to buy currency for a payment due in three months. She sets an entry point for each tranche, buying one third when the rate reaches a target and the rest at later levels. This spreads the risk of a poorly timed purchase.
Formula
Calculation
Reward-to-risk ratio = (Target price - Entry price) / (Entry price - Stop-loss price)
Position size = Amount willing to risk / (Entry price - Stop-loss price)
Suppose a trader plans to buy at an entry point of $50, with a stop-loss at $47 and a target of $59. The risk per share is 50 - 47 = $3 and the reward per share is 59 - 50 = $9, so the reward-to-risk ratio is 9 / 3 = 3. If she is willing to risk $900, her position size is 900 / 3 = 300 shares. The total cost is 300 x 50 = $15,000, and if the trade reaches the target the gain is 300 x 9 = $2,700.Case study
Seen in the real world.
Maple & Rowe Capital is a fictional investment boutique, and this story is illustrative. A junior analyst recommended buying shares in a retailer because she thought the business was undervalued, but she gave no price at which the firm should act. The portfolio manager bought immediately, and the price fell 12% over the next fortnight before recovering.
After the episode, the firm introduced a rule that every recommendation must state an entry point, a stop-loss and a target. The next recommendation specified an entry price 8% lower than the market price, which was reached within three weeks. The firm noted that the extra discipline did not remove losses, but it made the decisions easier to review and explain.
Watch out
Common mistakes.
- Entering a trade without knowing where to exit if it goes wrong.
- Chasing a rising price instead of waiting for the planned entry point.
- Choosing an entry point without sizing the position to the amount of risk that can be tolerated.
Questions
People also ask.
How do traders choose an entry point?
They use chart levels, valuation work, signals from indicators or a mix of these, depending on their style.
Is the entry point the same as the entry price?
In practice they are close, although the point is the plan and the entry price is what the trade actually achieves after costs and slippage.
Does it apply to long-term investors?
Yes, because even a long-term buyer benefits from deciding what price offers enough margin of safety.
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