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Managing Your Trade

FOREX Trading Strategies

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An In-depth Consideration To Exiting A Trade

The second most difficult aspect to trading is deciding when and where to exit a trade once you have entered. There is plenty of information you can find on how to enter a trade, but on how to exit a trade such information is nearly non-existent.

As a trader, Analyst and teacher of the art of trading for over a decade now, I have had my share of experiences in different approaches to exiting a trade, and have come to several conclusions as to the effectiveness of each approach and on the art of trade exits altogether. One conclusion is that there is not one single exit strategy for all trading situations. No wonder most avoid this subject when putting together books on trading.

Because I have personally used several approaches with varying degrees of success (and failure), and because of the lack of information in this area of trading, I have decided to put together this article in hopes that it will enlighten all sorts of traders to the methods available to them.

Before we actually touch on some of the methods of managing your trade once you have entered into the lions den of committed capital, it is important that you understand that there is not one single trade management approach that is all encompassing for all trades and markets. One method may provide you with the most amount of profit in one trading scenario, such as when applied to a strongly trending market, while that same approach would provide you with less profit than another approach in a completely different trading scenario, such as a choppy or cycling market.

It isn't always as simple as noting the type of trading scenario you have entered into and then picking the right exit strategy to go with it. Sometimes, it may be a matter of simply having chosen the right exit strategy by happenstance, as trading scenarios can change without notice many times.

The trader must understand that the capturing of most of a move may not always be the result using any particular exit strategy, and to simply be happy to take a good portion out of the market in profit territory. The bottom line is working your trades so that you can get profit that exceeds the amount you originally risked in the entry. But understand this. If you did not properly enter the trade in the first place, or have accepted a larger risk than you should have for a trade that does not have the profit objective you think it does, no exit strategy will make this situation better. You should then be happy to get out with little or no loss, and not to blame your exit strategy for the quick exit.

One more thing before I go into some strategies found within my personal logs. A short-term trader is one who does not plan to remain in a trade for more than a few days, as opposed to a trader that is more longer-term. Some exit strategies are geared more toward the short-term trader while other exit strategies are better suited to those who wish to stay in the trade longer and can handle adverse market moves. You must first figure out what kind of trader you are, short-term or long-term, so that you will know which strategy best fits your personality.

(Note: All examples will assume the trader is LONG in the market. Simply reverse the explanation in the event you are SHORT.)

3-Day Extreme Method
This is one of my favorite exit strategies and is easy to use. There are two ways to implement this strategy, so I'll first start with the basic approach.

Approach #1: Once you are in the trade, you must place an initial stop-loss to limit your losses in the event you have entered too early or have chosen the wrong direction to trade. With this approach, your initial stop-loss is placed below the lowest low of the last three trading days. Each day, you must adjust your stop-loss up to just below the lowest low of the last three trading days until stopped out. When counting the three days, they are the last three trading days that have already closed. If you have a profit objective that has been met, start moving your stop-loss below the low of day that has closed until stopped out.

Approach #2: This approach requires that you are a trader that takes advantage of reversal dates, such as Fdates used by our membership. With this exit approach, your initial stop-loss is placed just below the low of the actual day we enter our trade for less initial risk exposure. Once the low of the last three trading days is higher than where we have placed our initial stop-loss order, we start to move up our stop-loss to just below the lowest low of the last three trading days. Once we arrive at the date of the next reversal due, we can then move our stop-loss up to just below the low of that day after it has closed. In the event the reversal does occur, you are stopped out at its formation with less erosion of your trading profits.

62% Ratio Method
This approach works on the premise that a good trend in motion will not retrace more than 50% of the previous move, but 62% at the maximum. The idea is to stay in the trade even during market corrections against your position as long at it does not correct more than 62%, thus suggesting the trend is ending. This method requires that you have a profit objective in mind, so that you can readjust your ratio tighter for the final days of the trade. To implement, simply take the previous range where the low is lower and the high is higher than where you have entered. Calculate a 62% correction from that top towards that bottom and place your stop-loss just below that value. If you have entered from a price that has not previous range to reference (such as the beginning of a new trend), use the bottom of that new trend to place your initial stop-loss below. Once the market moves up and then starts back down again, you now have a bottom to top to calculate from and immediately move your stop-loss up to just below 62 % of that bottom to top range. Once price resumes its upward move again forming a new swing bottom and exceeds the price of the previous top (where the correction began), immediately move your stop-loss to just below that new swing bottom. Repeat the 62% procedure as soon as the next top is forming and the market is correcting. Once you have reached your profit objective, consider decreasing your ratio down to 50% or 38% to lock in profits.

3x2 Exponential Moving Average Exit Strategy
This approach requires that you have software at your disposal that can calculate a 3-day exponential moving average with a 2-day offset. The use of this moving average is very simple to implement. If you are long, set your 3x2 Ema to average off of the last 3 days of LOW prices. If you are short, then set the 3x2 Ema to average off the last 3 days of HIGH prices. Use each day after the close note the 3x2 Ema value and then place your stop-loss just below it prior to the open each day. This approach is for very short-term trades and will likely get you out at the first sign of any correction.

Trend Line Exit Strategy
This is a simple approach that requires a correction to occur against your position before you can start implementing it. A valid correction for this method is one that is at least 38% of the previous range. It is calculated just like the 62% Ratio method, except you do not move your stop-loss UNTIL the correction is over. If a correction occurs that is at least 38% of the previous range, and then the trend resumes it profitable course forming a swing bottom, a trend line is then drawn from the previous swing bottom prior to your entry price to the newly formed swing bottom and out into the future (a straight line). You then can start moving your stop-loss just below this trend line for each trading day until another correction of 38% or greater forms a new swing bottom. Once done, you would then redraw your trend line from the last swing bottom to the newly formed swing bottom into the future. Again, move your stop-loss to just below this line for each trading day until either stopped out or a new line can be drawn. Keep in mind that each new line will develop a sharper angle upwards than the last until you are stopped out.

18-day Simple Moving Average
This is a very simple stop-loss approach. You place your initial stop-loss just below the lowest-low of the last 3 trading days. Once a price bar on your chart forms with a higher low than the 18-day simple moving average of the closing price, the stop-loss is then place just a few ticks below the 18-day ma prior to each day's open until stopped out.

The approaches are basically the same, except you would apply the short-term strategies to a weekly price chart rather than the daily price chart. Thus, an 18-day moving average on the weekly price chart would actually be an 18-week moving average. Simply view each weekly bar the way you would view the daily price bars when implementing these short-term strategies for longer-term trading.

For those who use my Fdates for reversal timing, Wdates would be used in place of Fdates for the 3-Day Extreme method (Approach #2). However, it would be the 3-Week Extreme method when applied to the weekly price chart.

These are just some of the approaches to exiting a trade that is available to you. It is hardly conclusive, just as the saying goes "that there is more than one way to skin a cat" (Disclaimer to all animal activists: I do not condone the skinning of cats. This is just a figure of speech. ;)

Hopefully, this article will give you a place to start, and from here you may just discover an approach that works best for your method of trade entry.

As I mentioned at the beginning of this article, managing a trade is the second hardest part of trading. What is the hardest part? Discipline. That is an article for another day.

Note: About the Author
Rick J. Ratchford is President of ProfitMax Trading Inc. He is a full-time commodity trader for his own account as well as assisting other traders. He has been a computer programmer for more than 20 years and a trader since 1990.