Introduction
When it comes to trading, many individuals devote significant time and energy to identifying the perfect entry point. While this is undeniably crucial, it is equally important to consider the optimal exit strategy. Ultimately, how traders choose to exit their trades has a significant impact on their overall success. In this article, we will explore three highly effective trading exit strategies that traders should thoroughly evaluate.
Forex Exit Strategy #1: Traditional Stop/Limit (Using Support and Resistance)
One approach that traders can adopt is the traditional stop/limit method, which involves utilizing support and resistance levels. By setting both stop and limit orders at the time of trade entry, traders are able to keep their emotions in check and minimize risk. This strategy is far more superior compared to entering a trade without a stop loss and enduring the stress of potential losses eating away at one’s account equity.
Research conducted by DailyFX has revealed that successful traders often adhere to a risk to reward ratio of at least 1:1. Therefore, before entering a trade, it is essential for traders to analyze the level of risk they are willing to assume. They should then set a stop order at that predetermined level of risk, while simultaneously placing a limit order a certain distance away. This ensures that if the trade moves in the wrong direction, it will be automatically closed at an acceptable level of risk. On the other hand, if the trade moves favorably and hits the target, it will also be automatically closed, providing traders with a desirable exit point.
It is worth noting that well-defined support and resistance are key elements in this strategy. For instance, in the case of the USD/JPY currency pair, traders looking to go long should wait for the price to bounce off a supportive level, while simultaneously relying on clear buy signals from indicators. As price temporarily breaks below support, traders would then position their stop order slightly below the support level, while placing their limit order at the resistance level. Conversely, for short positions, this approach would be reversed, with stops placed near resistance and limits placed at support.
Forex Exit Strategy #2: Moving Average Trailing Stops
Another effective exit strategy involves utilizing moving averages as trailing stops. Moving averages serve as valuable tools for identifying the direction in which a currency pair is trending. Typically, traders look for buying opportunities when the price is above a moving average and selling opportunities when the price is below a moving average. However, moving averages can also be employed as trailing stops.
The concept behind this strategy is straightforward. When a moving average crosses over the price, it indicates a shift in trend. At this point, trend traders may choose to close out their positions. Hence, setting stop losses based on moving averages can prove to be an effective technique.
For example, let’s consider a scenario where a long entry is initiated above a resistance breakout, which also surpasses the 100-day simple moving average. In this case, the stop order is placed 220 points away at the moving average, while the limit order is situated 440 points away to maintain a favorable risk to reward ratio of 1:2. As the price continues to rise, the moving average moves along with it. Consequently, the stop order must be adjusted accordingly to serve as a safety net in the event of a sharp price reversal.
Forex Exit Strategy #3: Volatility-Based Approach Using ATR
The final strategy we will explore centers around utilizing the Average True Range (ATR) to gauge market volatility. The ATR allows traders to measure the extent of market unpredictability. By calculating the average range between the high and low prices over the past 14 periods, the ATR provides valuable insights into market behavior, which can be effectively utilized to determine appropriate stop and limit levels for each trade.
Traders must consider the ATR of a given currency pair before establishing stop and limit orders. As a general rule, the more volatile a pair, the wider the stop should be set. This precautionary measure is necessary because implementing a tight stop on a highly volatile pair may result in premature stop-outs. Conversely, setting excessively wide stops for relatively stable pairs poses unnecessary risk.
It is important to note that the ATR proves to be a versatile indicator as it can be adapted to any time frame. To effectively implement this strategy, traders should set their stop orders just above 100% of the ATR value, while placing their limit orders at a distance equal to or greater than the ATR from the entry point.
Conclusion
Trading successfully in the forex market extends far beyond identifying opportune entry points. How traders exit their positions plays a critical role in determining overall profitability. Implementing effective exit strategies can significantly enhance trading performance. New traders are strongly advised to develop a comprehensive trading plan with a precise exit strategy, which will serve to cultivate confidence. Furthermore, it is essential to remember that efficient exit strategies represent just one component of a holistic forex trading strategy. Traders are encouraged to explore additional top forex trading strategies to further refine their approach and increase their chances of success.