A trader's path from entry to exit is as crucial to profitability as their trading plan. Smart traders plan their entries, exits and reactions ahead of time. They plot their course based on fundamentals, technical analysis and their trading psychology.
An exit strategy defines how you exit trading positions. It helps sharpen your trading focus and ensure you close out trades based on predefined criteria, such as your profit target or loss limit.
By maintaining a defined exit plan, traders avoid emotional trading, which can lead to trading mistakes. Having a clear exit strategy also improves your discipline as a trader, enabling you to stick to your plan, even when circumstances change.
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5 Tips for a Good Exit Strategy
1. A simple exit strategy might involve placing a stop-loss order and target profit
A proper exit strategy has many facets that you need to consider whenever entering into a forex trade. It often consists of three steps, which are "setting entry", "setting stop loss", and "setting take-profit" orders. The term "trailing stop order" is also used in place of "stop loss".
Most forex traders employ stop-loss orders, but they don't realize that a stop-loss order on its own can be a poor exit strategy. A stop-loss order usually triggers when the price of a currency pair falls by a certain percentage.
However, a stop-loss order can be triggered even when there is a sharp movement in the currency market, so traders end up losing more than anticipated. To avoid losing money using stop-loss orders, traders should employ a target profit strategy.
Unlike a stop-loss order, a target profit strategy triggers when the price of a currency pair rises to a certain percentage. Traders can set a target profit percentage as high or low as they want, depending on their risk tolerance. One can also vary the target profit percentage if the market fluctuates.
While a basic exit strategy is easy to implement, a more complex plan might include multiple stop losses and profit targets. Moving averages can help determine when to enter and exit forex trades and where to place these stop losses and profit orders with confidence.
2. Exit strategies, like trading strategies, are flexible and dynamic
When you're new to forex, it's easy to think that your exit and trading strategies are the same. But they're not.
Like trading strategies, exit strategies are also dynamic, and constant changes in market conditions or market sentiment can necessitate frequent adjustments. An exit strategy is how you react to the market, and it may or may not involve changing positions. Exit strategies involve more than just technical analysis. It also considers psychology, regulation, and liquidity.
Every investor needs an exit strategy. Some forex traders are most comfortable basing their exit strategy on fundamental factors — economic news, trend lines, moving averages, and more. Others prefer to use technical aspects, such as price patterns, indicators, oscillators, and fractals.
Part of what makes forex so attractive is its flexibility. There are no hard-and-fast rules about your exit strategy because forex traders are diverse, and no two traders trade the same way.
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3. Traders should plan their exit strategy in advance
Many traders have an exit strategy, but many fail to execute it. Some traders consider the exit to be an emergency that happens when something goes wrong. Exit strategies should be part of your trading plan. One of the primary reasons for having a trading plan is to have control over your trades.
Using critical support and resistance levels, traders can plan their exit strategy. A good exit strategy will prevent further loss of capital by taking the trade-off at predetermined points. Traders want to minimize their losses as much as possible, and planning is the key to doing that. Having an exit strategy before entering trades will help traders control their trading habits and be more consistent in their decision-making process.
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4. Know when to exit
Exiting when the price is right is the best strategy. However, the best exit strategy is often not the one you believe to be the best. Most forex traders believe buying at the top and selling at the bottom is the best exit strategy. However, if you follow this advice, you will simply be chasing a moving target and will never make a consistent profit.
Instead, trading with the trend is the best exit strategy. A trend is a continuous flow of price changes. There are many different types of moving price changes, but trends are the most consistent. Trends can change quickly or slowly over time. The best exit strategy, regardless of the size of the trend, is to trade with it. On the other hand, knowing when to exit is just as important as trading with the trend.
5. You should tailor your exit plan to your trading strategy
Forex traders must develop a strategy before they can begin trading. Therefore, one must always consider the exit strategy as well. The exit strategy should match one's trading strategy. The two go hand in hand.
For example, scalpers should not get caught up in their trading and hold on to losing positions too long. Instead, they should exit when a position reaches its profit target. For longer-term positions, you can adopt a buy-and-hold approach. You can choose to close a trade when you hit the profit target or loss limit. You can also exit trades early if you encounter a critical event, such as an essential economic data release.
Traders don't need to follow a strict exit strategy, but they should define criteria to guide their trading decisions. The exit criteria should also consider the asset's price, volatility and position in the time frame.
For example, consider an asset that trades in a narrow price range with a high degree of volatility. Traders should define their exit criteria based on those factors. When an asset is volatile, traders should set their profit target high. This limits their losses and ensures that their profit targets are reached quickly.