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Is it knowing when to get in or knowing when to get out of a trade that makes becoming a successful Forex trader such a challenging endeavor?
I would argue that both are equally important. These two elements, among many others, need to work in harmony if you want to grow your trading account.
But as unsuspecting as it may seem, knowing when to get out of a position is perhaps the more challenging of the two.
This is likely because before you get into a position there are no emotional strings attached. However, once you have money on the line, everything suddenly becomes that much more complicated and confusing.
All of a sudden your trading plan gets altered or forgotten entirely. That key level you had previously defined gets moved a bit higher or lower, as long as it keeps you in the trade. And of course, the most common of all, you decide to move your target farther away in an effort to make more money.
These are all major challenges that the aspiring trader must deal with.
Luckily, there are a few plain and simple ways to determine the right time to book profits. The real magic behind the topics below is that they are all objective ways of viewing the market. This will help you keep your emotions in check while deciding when you should close a position for a profit.
So without further delay, let’s get started!
The very first step when it comes to taking profits is to know where the key support and resistance levels are on your chart.
In fact, this should be the very first thing you do every time you open a new chart. After all, you can’t determine a target unless you have these key levels marked.
You should always have a solid understanding of exactly where the market may encounter an increase in supply or demand. This will allow you to “trade between the levels” so to speak, which is what trading with price action is all about.
But it isn’t enough to simply draw a few lines on your chart and call it a day. You have to be confident enough in your abilities to trust that these levels are accurate so that you can manage each position accordingly.
One thing that will help with this is knowing that support and resistance levels are rarely sporadic. There is typically a pattern of sorts when it comes to the number of pips between each level.
Take the chart below as an example. Notice how each level is spaced fairly evenly apart.
This happens more than most Forex traders realize. Knowing this will allow you to double check your work in the event you see an abnormally large space between two levels.
Here is a great example:
Notice the large space between two of the levels compared to the rest of the price action. If you come across something like this, chances are you overlooked a key level somewhere in your analysis.
This is yet another reason why you should always draw your levels prior to entering a position. Otherwise you may find your subconscious omitting certain levels in an effort to make a trade setup look more appealing than it actually is.
Like all things in the Forex market, this idea of “regular” spacing between levels should be thought of as more of a guideline rather than a hard-and-fast rule. It won’t work on every chart or in every circumstance, however, it does happen more often than not.
I love chart patterns. One reason I love them is due to the measured objectives that can be used with most of the more common price structures.
These objectives allow you to easily determine how far a market is likely to move after the technical pattern is confirmed.
Let’s use the head and shoulders pattern as an example.
Note how the measured objective is found by first measuring the distance from the head to the neckline and then projecting that same distance from the neckline to a lower point in the market. It’s important to remember to measure lower from the breakout point, not from the middle of the pattern.
As powerful as these measured objectives can be, they are not the be-all and end-all of knowing when to take profit. Just like anything else in the world of Forex, we need confluence in order to have confidence in our plan.
That confidence is found when an objective lines up with a predetermined level of support or resistance.
The head and shoulders that formed on the NZDJPY chart below is a great example.
Notice how the 1,000 pip objective lined up perfectly with former swing lows. This gave me the confidence to know that the potential for a massive 1,000 pip move was not only possible, it was probable.
As price action traders, we use the movement of the market to our advantage. These movements allow us to determine whether a favorable formation has emerged or whether current market conditions are best observed from the sidelines.
But using price action to your advantage doesn’t stop at identifying favorable entries.
The signals you use to enter the market can be just as telling when it comes to knowing when to take profit.
For example, a bullish pin bar at key support when you are 300 pips in profit from a short entry may signal that it’s time to book profits. While the bullish pin bar may not amount to much, especially if it is against the momentum, it may not be worth risking the 300 pips of unrealized profit to find out.
The same holds true for certain Forex chart patterns. A head and shoulders formation that occurs while you have exposure to the long side may signal that an exit is in order.
As we know, a head and shoulders is a sign that the market may be getting ready to reverse its trend. And you don’t want to risk giving back any gains you may have made on the run up to the topping pattern.
At the end of the day, being a price action trader isn’t just about using price movement to enter the market at favorable locations. It’s about “reading” the entire market to identify the most opportunistic areas to both enter and exit the market for a profit.
As a pure technical trader who relies on price action to make decisions, I never trade the news. I don’t base my decisions on whether the non-farm payroll figure is “good” or “bad” or whether the European Central Bank (ECB) is hawkish or dovish in its statement.
I do, however, care about how the market responds to such events. In other words, I’m more interested in reading the news via the price action on my charts rather than reading the news itself.
One thing I have learned over the years is that the market has a funny way of reversing on heavy event risk after an extended move up or down.
What do I mean, exactly?
Recent price action on EURUSD is a perfect example. The market had sold off to the tune of almost 1,000 pips leading up to an ECB rate statement. And if you’ll notice, there hadn’t been much of a pullback along the way.
Shortly after this announcement, the pair rocketed 400 pips higher, taking out the previous 20 days’ worth of gains.
Now, I’m not insinuating that this kind of move can be predicted. As you may well know, becoming a profitable Forex trader is not about attempting to predict future price movement.
Instead, it’s about getting yourself into probable and favorable positions and then remaining diligent, especially when managing unrealized gains.
That said, I have seen this type of pattern time and time again. The market moves for weeks or even months without a healthy pullback before heavy event risk derails the momentum.
So what is the lesson to be learned here, you ask?
Put simply, you have two options if you’re facing a high-impact event that could move against your open position. You can either book profits ahead of the event or trail your stop loss so as to protect a portion of your unrealized gains.
An argument can be made for either option, so it’s really up to you to decide which one is most appropriate for your style of trading.
Do note, however, that there is no such thing as a guaranteed stop loss order. This is especially true during times when an increase in volatility clashes with a decrease in liquidity.
If this happens, your broker may have trouble getting you out of a position at an optimal price.
That said, the best option remains the one you feel most comfortable with. Perhaps the only wrong decision here is to make no decision at all and allow the market to take you out of a once-favorable position for a loss.
As human beings, we have a tendency to get complacent when things are going our way. But as a trader, that complacency can cost you unless you learn to stay diligent from the time you open a position to the time you close it.
As obvious as it may seem to determine the strength of a trend based on the highs and lows of the market, many Forex traders overlook this as a tool to help them decide on the best time to book profits.
The very foundation of price action is built upon highs and lows. They give us our key levels from which to trade and also provide favorable areas to “hide” our stop loss orders.
However, they are also extremely helpful when it comes to determining the strength of a given trend. This can be a huge advantage when trying to decide if you should book profits or not.
A downtrend, for example, is traditionally defined as a market that is making lower highs and lower lows. The opposite of this is a market that is making higher highs and higher lows, which refers to a market that is in an uptrend.
It probably goes without saying then, that a breach of one of these highs or lows could be a sign that the market is getting ready to reverse its trend.
The AUDUSD weekly chart below shows a strong uptrend that reversed once a lower low had formed.
Notice how, after making an extended move higher, AUDUSD entered into a period of consolidation. However, what signaled that the trend was reversing was the lower low and lower high that formed shortly after the consolidation ended.
While the example above shows the weekly time frame, the same idea applies to all time frames. That said, in my experience the higher time frames tend to produce price structures that are easier to read and thus, easier to trade than the lower time frames.
Regardless of the methods you use to determine when to take profits, one thing must always be true – the approach must be calculated and objective in nature.
Many Forex traders make the mistake of exiting a position for fear of giving back unrealized gains. And while you do want to protect gains in order to build your trading account, booking profits for fear alone is never a good idea.
Instead, use the clues the market gives you to decide the best time to exit. This allows you to stay objective by basing your decision on what the market is doing rather than basing it on what you fear might happen.
What methods do you use to take profit? Share your experience or ask a question below and I will be sure to answer.
Justin Bennett is an internationally recognized Forex trader with 10+ years of experience. He's been interviewed by Stocks & Commodities Magazine as a featured trader for the month and is mentioned weekly by Forex Factory next to publications from CNN and Bloomberg. Justin created Daily Price Action in 2014 and has since grown the monthly readership to over 100,000 Forex traders and has personally mentored more than 3,000 students.Read more...
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