Forex Exit strategy is a crucial but often overlooked aspect of trading in the Forex markets. Exits are important as they determine:
- the size of your profit
- the size of your loss
- the length of your trade
- the % of time that you win
- your net profitability
Traders often find it a lot easier to enter positions than to exit them, the most common reason being that initial expectations of the trade are unrealistic.
Many trades will initially make money only for those profits to evaporate and turn into losses. Traders often expect too much from a trade and fail to take precautionary measures to protect accrued profits. Exit is difficult because unlike ‘entry’ it must be made on the ‘market’s terms’ and not our own. It’s therefor important to have:
1) realistic assumptions about the future performance of trades
2) well defined exit criteria for each and every trade.
Let’s take a look at some of the best trade exit strategies and methodologies you can use to improve your trading performance:
Stop Loss
A stop loss is a protective mechanism whereby a trade is exited on a stop order as soon as the price trades through that predetermined level. This initial stop determines your risk and allows you to correctly size your trades.
The size of the initial stop will control your trade win percentage. Smaller stops typically produce smaller winning percentages. It’s important to place stops outside recent market noise which can be measured using an indicator such as the ATR (Average True Range). 3-4 ATR stops typically work well on most time frames.
Stops can also be set outside recent swing highs / lows, support / resistance, lowest low / highest high of the last n period (Donchian Channel), or above / below an n period moving average.
The important thing to remember is that the closer your stop the more likely it is that you will be stopped out by random market noise.
Profit Protection Stop
A profit protection stop prevents a profitable trade from turning into a losing one. Once a trade has captured a predefined amount of profit, the initial stop is tightened and moved in to lock in profit and prevent give back.
One method that can be used is the ‘trailing stop’ which slowly trails behind the market price. It’s important not to trail the stop too closely in the initial stages of a trade or you will be stopped out prematurely. Use ATR indicator to assess how closely the stop should be trailing.
Once a decent amount of profit has been obtained (4-5 times the amount of your initial risk) profit protection stops can be trailed more closely to reduce open profit give back.
Profit Maximizing Exit
A profit maximizing exit uses a limit order to exit as soon as price trades through the limit price. Profit maximizing exits are different to stop losses and profit protection stops in that they exit in the direction of positive momentum and incur no negative slippage or give back of profits. The downside is that trades may be exited too early as price continues to move in its established direction.
Typical exit problems
Most of the problems traders encounter with exits are caused by stops that are set too close, leading to numerous stopped out trades, or overoptimistic assumptions about a trades potential: turning winning trades into losing trades.
Trading Solution: Scale out Exits
Partially scaling out of trades through multiple units using limit orders allows traders to reduce open profit ‘give back’ and account volatility, while remaining units can still ride out profits from long tail moves.
