Taking a profit is often an overlooked aspect of trading. Yet, no matter how you look at it — the only way to earn money is to keep closing profitable trades. Resisting greed is not always easy, but there is a fine line between it and accepting reasonable returns.
Read on to learn about various angles you might consider when designing a trade exit.
Exiting = Cash
You made a good bet, the market has moved in your direction, and the screen is full of green. Yet, before that green makes its way into your wallet, it still sits on no man’s land.
To properly exit a trade, you need to have a plan. Spontaneity is not a trader’s friend, as it makes you break the rules. Without rules in place, you’ll never know if you can attribute the results to pure luck.
Popular Forex Exit Strategies
Whether you are a short-term or a long-term trader, these are some of the exit strategies you might consider.
- Stop-limit order: This is your primary tool when planning trade exit. To exit the trade is a limit order that will execute only when a target price is hit. Yet, be careful with gaps in forex as they can bypass the stops.
- Trailing stop: When you’ve made a profit, you might consider using a trailing stop. This is a floating limit order that adjusts at a fixed rate depending on the price movement. For example, if you sold at 1.18700 and the price is currently at 1.18500, you would be 20 percentage-in-points(pips) up. A pip is equivalent to 1 basis point, or 1/100 of 1%.
A trailing stop of 5 pips would set the threshold at 1.18550, securing at least 15 pips if the market moves against you. Yet, if the market drops further to 1.18400, now the trailing stop will be at 1.18450 — securing a profit of 25 pips minimum.
- Moving average: These are some of the most popular indicators of all time. It is a graphical representation of the average price movement over time. More importantly, many traders use it in their research, effectively making it a self-fulfilling prophecy. So, exiting a trade before a price hits the moving average and pulls back can be a legitimate strategy. While swing traders like to use 50-day and 200-day simple moving averages, exponential moving averages might be better for short-term trading. It emphasizes the recent price action, with periods 14 and 21 being the most popular.
- Relative Strength Index: Also known as RSI, it is a technical indicator that charts the strength and weakness of momentum based on the recent closing prices. By computing a velocity of higher closes to lower closes, it creates visual momentum on the scale of 0 to 100. Levels 70 and 30 are thresholds, with a cross above 70 classifying the price as overbought and a dip below 30 as oversold.
A simple exiting strategy would be to close a long once the price is overbought and close a short once the price is oversold. The main weakness is that, although it might work well in the periods when the market is ranging, you would be missing out on profit when the market is trending — as the price can stay in the overbought and oversold territory for a long time.
- Support and resistance: One of the oldest concepts in technical analysis, support and resistance are predetermined levels where the price might stop (at least temporarily). These levels are purely speculative and depend on the historical price action. While there are no guarantees that the history will repeat, it often rhymes enough for this concept to be useful. Taking profits before the price hits a strong support level (for sell) or a resistance level (for a buy) is one way to avoid sitting through any pullbacks.
- Order block: A dynamic level of support and resistance, order block is an observable point where the price paused in a trend. You can detect it by looking for short upward bursts in the downtrend or a short downward burst in an uptrend. By drawing the line through the middle, you will get a level to work with. If you anticipate the price to reject from this level, setting it as a profit target would be a good idea.
- Average true range (ATR): One of the best market volatility indicators, ATR shows the average volatility of price over a period of time. It gives you the potential upside (or downside) of a forex pair based on the recent historical price. Intraday traders can use this to set their expectations; for example, if a daily range is 90 pips, your reasonable expectations can be 30% of that. ATR can be used to set a fixed stop-loss, with 10% as a solid recommendation.
- Break in the market structure: Carefully observing your position(s) can save you a lot of money but comes at the expense of time. Regardless of all the indicators, price action will always be the king. After all, indicators are all a derivation of price — simply explaining the events that have transpired. When you hold a position for a more extended period, you have to pay attention to the market structure. Take notice of these questions:
- Is the market still making higher highs or lower lows?
- Where is the support below the market?
- Where is resistance above the market?
- What is the sentiment on the upcoming news?
These are just some of the questions that will keep you in check. Babysitting a trade can be exhausting but worth it if you are trading at a larger size.
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Staying in the Zone
When you’re in a profitable position, your brain releases pleasuring chemicals, rewarding you for a job well done.
This is one of the traps that many traders fall into without realizing. Mark Douglas, author of the bestseller “Trading in the Zone,” claims that our brain is lying to us. By distorting the objective reality, it doesn’t want the pleasure to end but also for the pain to present itself.
This is why traders often refuse to close big winners and even the big losers. Yet, the solution is to make peace with the fact that you don’t know what will happen next. Without expectations, you are letting the market tell you what is likely to happen next.
This is critical information in objectively deciding when to stay and when to go.
Frequently Asked Questions
How do you know when to close a forex trade?
This will highly depend on your strategy. You should have a plan for exit in both good or bad scenarios before entering a trade.
This way, you will mentally prepare for a maximum possible loss while having an estimate of the potential profits as well. Using one of the strategies discussed above will help in that regard.
When should you close a trade?
If things are not going as planned or have been in a trade for a long time and have not moved, you should consider closing a trade. Babysitting a trade can be mentally taxing and you might also free up your capital for better opportunities.
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