6th August 2019
Profits (and losses) are made when you exit a trade, and in some ways how, when, and why you exit a trade is even more important than the entry.
Whenever you enter a trade, you should have a very specific exit strategy in mind, with the objective of maximizing your profit. That means the exit strategy should be adapted according to the type of trade you have entered.
Broadly speaking there are four ways to exit a winning trade:
Let’s look at a few different types of trades and the most appropriate way to exit each.
If you enter a trade because the price has broken a support or resistance level, you will probably expect momentum to increase as more market participants enter. If there is a major support or resistance level in the vicinity of the breakout, this will be a logical target for the price to test and exiting at that level will give you a good chance of maximizing your profit.
If there is no obvious support or resistance level to use as a target, the best you can do is use momentum as a guide. There is always a risk that the price will reverse back to the breakout level, and slowing momentum raises the chance of that happening.
If you are trading a chart pattern like a flag, a head and shoulders, or a wedge, the pattern will have a specific target. The price may not necessarily reach that target, and it may keep going when it reaches the target – but it’s still the most likely level you can use to exit. A lot of other traders will probably be using the same level as a target, so there’s a good chance the price will stop moving when it gets there. If you have entered a trade based on a pattern, there really is no reason to exit based on anything other than its target.
Momentum trades are based on the fact that momentum attracts new buyers (or sellers) and the price keeps moving – until momentum slows. You really don’t know how far a momentum rally or selloff will go, and the best guide you have is the speed at which the price is moving. When the price slows down, there’s a very real possibility of everyone following the trade exiting. There is really no reason to stay in such a trade when the price slows down.
It’s also worth using a trailing stop to protect your profits with a momentum trade. You never know when the trend might reverse, and a trailing stop can help you protect your profit.
When it comes to an exit strategy for investors with a longer time horizon, you may want to bring fundamentals into the picture. Long term trades usually need more room to work, but if an asset is trading at historically expensive levels, there is no point giving up all your profit. The more overvalued you believe an investment to be, the tighter your stop loss or trailing stop should be.
A trailing stop is a stop loss that follows the price higher (or lower in the case of a short position) and helps to protect your profit in the case of a sudden price reversal. If you are not sure how far a trend may go, a trailing stop is a good way to ride the trend and protect your open profit. The following are three effective approaches to using trailing stops:
Moving averages offer a very easy-to-use method to apply a trailing stop. Simply find a moving average with a length that has followed the price action of recent trends without the price crossing it too many times.
If you are looking for a forex exit indicator, the ATR (average true range) may be the best indicator to exit a trade with. The ATR will rise and fall with volatility which means it adapts to the price action. One approach is to subtract 3x the value of the ATR from the highest price reached. Each time the price makes a new high, you move your stop loss to a price equal to the new high minus 3x the ATR. The ATR will change as volatility changes and keep your stop away from the noise, while still protecting your profits. You can also use Keltner Bands which combine a moving average with an ATR indicator.
Finally, you can use swing highs and swing lows to define a trailing stop. Prices seldom move in a straight line, rather forming trends that consist of a series of minor highs and minor lows. These are the swing highs and lows that define a trend. An uptrend is formed by a series of higher highs and higher lows, and a downtrend is formed by a series of lower highs and lower lows.
If you have a long position you can keep your stop just below the most recent swing low, and for a short position, you can keep it just above the most recent swing high. That way, when the trend starts to break down, you will automatically exit the trade.
As you can see, there is no single best exit strategy in trading and each trading plan you use may require a different exit strategy. Trading strategies are all different and so it makes sense that they may require different exit strategies. It is highly recommended that you use a demonstration account to practice any trading strategies in a risk-free environment before executing them on a live account.
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