To stay in or to exit a trade, that is the question.
Today’s article starts off with a philosophical twist, but it is in fact a real life, concrete and very practical issue for all Forex traders…
What is the best trade management for my trading plan?
It is important to address this concept in the trade management plan because taking random decisions per each trade will undoubtedly lead to emotional decisions.
The reason for that is simple: if we Forex traders are attempting to make the most profitable decision at each point of the trade life cycle (from entry to exit), then this will be impossible to do perfectly each and every trade. Sooner or later, there will be a point that a decision was less than optimal in retrospect.
What happens then? There are going to be points where we “wish” that a trade was kept open or closed. These thoughts in turn led to emotional imbalance and frustration. Traders get fearful, impatient, undisciplined, and greedy, to name a few of the unwanted consequences.
BASICS OF EXITS
First and foremost, all traders must accept that it is impossible to achieve a perfect exit for each and every trade in all cases. End of story.
Point two: all Forex traders must have their trade management plan written down. Our goal is to follow the plan so as we aim for long-term profitability. We want to avoid taking ad random decisions per individual trade.
With that said, how can traders improve the trade management plan to exit at a decent spot without too much stress and worry?
TRUE CAUSE OF FEAR
As all Forex traders know, the market makes tons of ups and downs on all time frames. The market loves to retrace and pullback. It retraces almost all candle sticks (or 98% of them). It retraces swing highs and swing lows. And it even retraces a trend. Retracements come in all shapes and forms: from the very small to the very large.
All the retracements are the true cause of fear and confusion with traders. Amidst the trade many traders are wondering: will my trade be able to “survive” this pullback?
Ultimately it is about finding a trade management plan that matches your own trading psychology.
- Some traders will feel more comfortable with allowing more space for a trade to develop and are able to cope with a decent number of pullbacks before their target is hit. The statistics of these trades are often on the higher end of the Reward to Risk spectrum but on the lower side of the win versus loss percentage.
- Other traders perform better while giving less space for a trade to develop and are less inclined to deal with retracements. The statistics of these trades are often on the lower end of the Reward to Risk spectrum but on the higher side of the win versus loss percentage.
This choice will ultimately depend on the trader and their psychology.
What concepts can be used to improve one’s exit strategy?
METHODS FOR IMPROVING EXITS in FOREX
Obviously classical support and resistance levels are very important. When price approaches a key level then there is a decent chance of price pausing, retracing or even reversing at and from this level. Other aspects are chart patterns and trend lines, which are classical and important methods of technical analysis. But there are more elements…
One simple but effective method which can be used in everyone’s trade management plan is momentum (very important for the Double Trend Trap strategy).
Momentum will provide crucial information whether the bulls or bears or none of the 2 are in control. When price is building on consistent higher highs and higher lows, or lower lows and lowers, then one side is clearly in more control. The candle sticks provide us with that information.
Some of the readers might be wondering: am I not referring to a trend? The answer is no. The trend is important for a directional bias in your trading, but it does not necessarily mean that the trend is in control at all times. As we know from the above paragraphs, despite trending modes, price tends to make tons of retracements. Price in fact moves up and down, also when there is a trend in play. Although the trend does provide us an edge in which direction has best odds for profitability, it does not automatically answer which side is in control.
Momentum does explain which side has the upper hand in the tug of war. Using the momentum concept to exit is very useful for a trade management plan. Let’s review the details how traders can do so.
USING MOMENTUM IN EXITS
The main characteristic of momentum is the fact that (almost) each candle stick has higher highs and higher lows for upside and lower lows and lower highs for downside. The trader can limit the risk of a future retracement by exiting a trader when the momentum is finished. Instead of a trader trying to survive many pullbacks and retracements, the trader can opt for an exit at the moment when a momentum move is finished.
The prime question is: when does momentum finish? Is there a way to have an idea when momentum finishes and when a correction, retracement, consolidation, or reversal starts?
The answer is: yes. Here is how.
- Keep a rigorous eye on each candle low in an uptrend and each candle high in a downtrend. These levels do not tend to break easily but sometimes do get smaller breaks. That is why using a leeway of a couple of pips is optimal. How many pips will depend on the time frame of your trade management. For an hourly chart 5-10 pips is sufficient. For a daily candle 15 pips would be better. Using a trail stop loss using the candle highs and lows with the mentioned number of pips would be the way of exiting a momentum.
- Keep a rigorous eye on each candle high in an uptrend and each candle low in a downtrend (opposite of the point 1). Each candle high in an uptrend should be higher than the previous one, otherwise the momentum might be in danger. The same holds true for each candle low in a downtrend, which should be lower than the previous one (otherwise the momentum might be in danger). Not every time a failure of a candle to cut the high or low turns into the end of a momentum. In my research the critical and crucial number has often been around 5-6 candles. When 5-6 candles fail to post a new candle high or low, then the chances of a momentum continuing are small at best. In that case, an immediate exit is justified and the trade has a high chance of exiting at the best spot prior to a bigger consolidation or retracement. Here is an example on the CAD using the same concept:
Be aware though that, after the consolidation or retracement has been completed, price can still continue with the momentum in the same direction, so do not beat yourself up if you regret the exit! Also remember that traders can always re-enter if they find sufficient evidence for a reentry.
Have you used momentum and correction for exits? What do YOU think of the rules mentioned in point 1 and 2?
Thanks for reading and sharing, plus Happy Trading!!
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