The popularity of currency trading or forex trading has been reaching new heights in the past few years. Due to the high liquidity and volatility of currencies, traders in the forex market always spot a lot of opportunities while monitoring the charts. They just need to choose an ideal trade setup and open a position based on their core strategy. Beginners spend a lot of time and effort finding the ideal entry points for a trade. But they forget to pay enough attention to planning the exit when it is just as crucial in determining the end result of a trade. You should also pay attention to the amount of margin you use per trade, as it should not exceed 2% of your total trading capital. You can use a margin calculator to calculate the margin accurately for every trade.
Today, you will get to learn about the top 3 exit strategies that can be followed in the forex market to boost your profit potential and minimise risk.
Trading Exit Strategies and Why They Are Relevant?
A trading exit strategy is the method you follow for closing a trade position. The exit strategy needs to be there before entering a trade. Otherwise, you might get overwhelmed and confused about the closing price later because traders tend to feel stressed and pressured about the profits and losses while the trade runs. This will result in brain fog, and traders will be unable to get the desired results. The strategy should cover your exit points in any situation, whether winning or losing the trade.
You should be planning the trade to make a maximum amount of profits, but you should be prepared to accept a minimum loss if the market moves in a different direction. You can think of it as a part of risk management, and a sound exit strategy functions as a powerful tool to manage the risk by managing your trades in a better way.
Now, let’s have a look at the most popular and effective trading strategies in forex that you can follow for profitable trading.
- Traditional stop/limit (using support and resistance)
- Moving average trailing stops
- Volatility-based approach using ATR
These strategies are framed for the same goal of getting the best possible trading results, but the method used to reach this goal will differ. Before we move forward to learning about these strategies, I want to mention the fact that these strategies are heavily based on technical analysis. So, you will need to have some understanding of the technical concepts and chart reading to follow these strategies with ease.
But they are still very basic and beginner-friendly, and you only need a little practice to master the techniques. There will be some calculations involved when it comes to calculating the accurate closing prices based on these techniques. It would be easier to do these calculations using tools like online trading calculators, which provide accurate results in split seconds.
1. Exit Strategy Based on Support and Resistance ( traditional stop/limit)
The first exit strategy is based on support and resistance levels which is often considered to be the foundation of technical analysis. Here, you will be relying on traditional stops and limits to automatically exit the trade in both favourable and unfavourable situations. The stop is set to close a trade when it hits the maximum amount of loss that you can take. Limits are actually targets for profit, and you will be exiting the trade at a profit as soon as these target levels are reached.
As you may already know, there are two types of positions that can be opened by a trader based on the market direction. An order to buy the currency pair is referred to as a long position, and it is opened when you expect the currency prices to move up. A short position is opened for selling the pair as the trader anticipates a downtrend in the pair where the prices will be falling.
While going long on a pair, a stop (Stop Loss) needs to be placed by analysing the charts to see if the price has broken below the support levels, and then you can set the stop slightly below the support level. When it comes to placing a limit or profit target (Take profit)), you need to do it based on the resistance levels. If you are confused about how the SL and TP will affect your profit potential or risk of loss, you need to perform some calculations beforehand to avoid any mistakes. You can also use a currency converter that converts any amount to your account’s base currency.
When you are planning to short a pair, the analysis will be reversed as you will be placing Stop at the resistance levels, and the limits will be placed closer to the support level. The traditional stop-and-limit exit strategy is very simple once you understand its basic concept. But beginners need to devote enough time to learning these basics, as even a minor mistake will invalidate the purpose of having a stop or limit order in the first place.
2. Exit Strategy Based on Moving Average Trailing Stop
Moving Averages have been a commonly used technical indicator for trading, and it also became a popular choice among forex traders as they give us valuable insights about the direction in which a currency pair may move. It is commonly used for identifying market trends. This indicator is used by a lot of beginners as they find it easy to use, and it does not add any complexity to the analysis. The price going above the Moving Average indicates an uptrend, and you can confirm a downtrend when the price consistently moves below the MA.
Those who follow trend trading strategies can effectively use this tool for framing their exit strategy. You can assume that the trend is about to shift when you see the Moving Average crossing over the price. This means you need to close the position right away. In this exit strategy, you will closely watch the MA when there is a market trend. In the case of a long position, the MA will move up along with the rising prices, and you can move your stop loss to the place where the MA is. Here, trailing stop loss refers to the practice of moving your stop loss based on the Moving Average levels. You can also set the limit or target based on the MA levels.
3. Exit Strategy Using ATR – Volatility-based Approach
The 3rd and final exit strategy involves using ATR (Average True Range), a volatility indicator. Hence, this exit strategy is suitable for those who want to follow a volatility-based approach. ATR is not a trend indicator and doesn’t give any information about the trend. Hence, those who want to consider the market trend along with volatility need to use other indicators such as MA or MACD as well. A volatility-based approach can be effective during volatile hours, as just knowing the direction of the trend won’t be sufficient to forecast the potential price movements with precision.
ATR measures the volatility by considering the average range between the high and low points for the most recent fluctuations, taking the last 14 candles. Having an idea about the market volatility is important for estimating the extent to which the prices can move. You can use this information to plan your exits. A pair having a higher ATR tells you about the high volatility of the pair at the moment. In this case, a tight stop loss will not work, as you might be stopped out way too early.
So, when the ATR is high, you need to place a wide stop loss so that the trade gets enough room to run without accidentally touching the SL. On the other hand, those who are trading with stable or less volatile pairs need to place tight stop loss as the pair is not likely to move much. In this case, you will take too much risk if you place a wider stop loss. The ATR indicator is flexible and can be set to any timeframe. You can set the stop a little above the 100% ATR, and the limit must be set at the same distance from the opening price.
In summary, the strategy you follow for exiting the trade is equally important as the analysis and technique followed for entering the trade. While opening a position, you are tapping into the opportunity, and how well you use it will be determined by the closing price or exit point. Finally, executing a profitable trade has much to do with timing, exit points, and risk management.