You Must Have an Exit Strategy

  • Elaboration on the importance of a preplanned exit strategy for all the trades you enter and how to develop and deploy one that best suits your trading strategy.
  • A well-planned exit strategy will minimize your risk exposure and reduce the negative psychological aspects of trading.
New forex traders usually spend most of their time considering how to enter trades without giving much thought about how they plan to exit them. Experts, on the other hand, pay very careful attention to their exit strategies and always know how they intend to exit their trades even before they enter. They employ a number of well tested exit strategies such as the following; they may decide to exit when a technical indicator has achieved a forecasted critical setting e.g. stochastic crossover, they may target a price level which they think price action can readily reach from prior considerations of technical and fundamental factors. Some traders prefer to select a time period within which their targets must be achieved otherwise they will be exit their applicable trades (especially to avoid holding trades over weekends because when the new week begins there are often significant price gaps).

Many traders insist that once you have entered a trade and have set your targets and stops, you must never change them. I do not support this point of view completely. I certainly agree that you should not widen your stop losses; otherwise you will expose yourself to increasing risk and psychological stress. Increasing stop losses in order to hope for a trade to turn in the desired direction is a very dangerous strategy that could place your entire budget at risk. It can be very difficult to control, if such a bad habit is started. Conversely, profit targets are very different because if you take them prematurely then you are, in fact, reducing your risk:reward ratio. This is definitely not a good strategy in the long term. Letting profits run is a widely recommended trading practice and, as such, if you can detect a trend that would allow you to do this then you are well advised to stick with it. However, another important trading condition that can arise is when a trade that you expect to move in a certain direction does the opposite. In such circumstances, you should consider whether to reduce the size of your target or even move your stop loss towards the opening price value (never away) in an effort to reduce your risk exposure.

You Must Have an Exit Strategy

In addition, great care should be taken if you find yourself trading under the following conditions. Suppose you have entered a short order because you are anticipating a price rebound from a resistance level. However, although a bounce back does occur, as expected, and is enough to activate your short, then price resumes its long trend with a strong momentum. Should this happen, you need to consider closing your trade down immediately to minimize your losses. To provide yourself with maximum protection, you need to become very experienced at studying charts so you can detect when these sort of patterns are beginning to materialize. You then need to know how best to respond to them in a manner that will secure you the best risk:reward ratio. This is simply a matter of studying charts and the way currency pairs move for a long period. Although you have decided on a specific stop loss level, it can be beneficial to reduce it if the currency pair is moving in a way which you did not expect. Maybe you expect a pair to have a strong bearish move, shortly after you enter a short trade due to some technical elements. If for some reason the pair keeps consolidating in a tight area for several hours, it is reasonable to assume that you were wrong. If this happens, you are better off closing the position.

One of the most heart-breaking experiences of forex trading is to watch a sizeable profit vanish before your eyes. Even worse is when your stop is knocked out as well and you incur a loss as a result. This situation is the woe of many forex traders and can often be attributed to poor money management.

One of the most important concepts of forex trading is to protect your profits. You are far wiser accepting a smaller profit of just a few pips than to expose yourself to large potential losses. The best forex traders are great survivors first and big earners afterwards. However, protecting your profits is not as easy as it sounds. For instance, at what particular profit level do you move your stop to, at least, breakeven. This important action will completely protect your budget for the trades in question. If you move it too soon, then you risk being stopped out only then to watch in frustration as the price moves rapidly back in your chosen direction. If, on the other hand, you wait too long, you could leave yourself vulnerable to a large price correction that could stop out your trade completely. The best way to overcome these problems is to determine the win:loss ratio and expectancy value of your selected forex trading strategy using either a demo account or risking very small amounts in a live micro account. These concepts have already been discussed in previous chapters.

Another method of locking in profits is to trade using two lots at the same time. With the first lot you can set a target based on the next resistance level (if you are going long) or the next support (if short) but they must be readily achievable. You can then set a far more ambitious target level for the second lot. Once the first target level is achieved, you can move the stop allocated to your second lot to breakeven, or better, allowing you to trade risk free from that point onwards.

Unbelievably, many traders do not consider viable exit strategies at all. You must realize from the outset that your exit strategy supported by good money management is vital to your success.

Here are a number of concepts that you should consider when designing your exit strategy.

First, you must always know where to place your initial protective stop. This action is essential in order to prevent you from suffering severe losses should the trade go against you early on.

In addition, your stop size must be well calculated in order to minimize your potential loss yet provide your new trade room to breathe.

Another defensive strategy would be to move your stop to breakeven as quickly as possible but still allow good chances for your trade to achieve sizeable profits. By designing a suitable method this would also provide the maximum protection for your budget.

Many traders use exit conditions based on a selected time period. This technique is especially useful during the releases of important fundamental data as these events can produce large increases in price volatility. For example, if you expect a certain response to an event to occur within one hour after its release, you could chose to exit your trade before this, no matter if it is a loss or profit.

Even after you have become more familiar with the forex market and its different trading patterns, you may still suffer strings of losses because it is such a dynamic environment. When losses start to mount up, traders have a tendency to increase their number of active trades or the size of their trades in an attempt to regain their budgets. However, this action is not recommended because usually it means that you have lost focus. A better option would be to consider taking a break. There is always tomorrow and another batch of new trading opportunities waiting for you. A good guide is to stop trading if you experience three or more straight losses in a row.

When you are designing your exit strategy, you should consider at least the following three questions:

1. How long do you want to stay in the trade?

2. How much risk are you prepared to take?

3. Where do you want to exit?

How long you will stay in a trade usually depends on what type of trader you are. If you are a long-term trader, then you should base your targets accordingly by examining the yearly oscillations of your chosen currency pair. You need also to develop a method of locking in profits when selected objectives are met. Your exit strategy should also consider key relevant fundamental data releases that could generate reversals during your trading time. If you are a short term trader, then your exit strategy needs to be based on achievable target levels and sound stop positions. To achieve this, you will need to consider fundamental and technical events that influence the short term. Assessing your risk exposure for every trade you enter is also an important feature of designing an exit strategy. The amount you are prepared to lose will influence the amount of time you are prepared to stay with your trade as well as the size of your stop-loss. You must determine the best way to prevent your stop-loss from being activated by the existing levels of market volatility. There are a number of technical indicators designed to help you do this.

In summary, exit strategies and other money management techniques can greatly enhance your trading by eliminating emotion and reducing risk. When you enter a trade, you must always identify a point where you will exit for loss and one where you will exit for a profit.