Chapter 16
In This Chapter
Closing out trades to maximize results
Taking profits and stopping losses
Exiting trades at the right time and price
Looking at your trading results to improve performance
Deciding how and when to exit, or close out, an open currency position is obviously one of the last steps in any currency strategy, but it’s also one of the most important. In our trading experience, no other part of a trading strategy has the potential to stir up greater feelings of self-recrimination by traders.
The classic trader’s lament is “coulda, woulda, shoulda.” And at no time is that sentiment more palpable than after a trade is closed out because that’s when the profit or loss has been registered and you’re looking at real money made or lost.
“Coulda, woulda, shoulda” refers to actions you may have taken in the market, but for some reason didn’t. In the context of exiting a position, it captures after-the-fact thoughts like “I could’ve taken profit when it was testing x level,” “I would’ve cut my losses sooner if I’d known it was going to keep going,” or “I should’ve stayed in longer for the big move.” The key is to understand beforehand that you’re never going to know with 100 percent certainty how the actions you take now will pan out in the future. In currency trading, you make more decisions in an hour or a day than most people make in a month, and that’s half the excitement!
If you ever find yourself thinking “coulda, woulda, shoulda” — and everyone does — you need to look back not at what you failed to do, but at why you failed to do it. This chapter covers some of the main considerations you face when it’s time to close out a position.
If you’ve embraced the idea of always trading with a plan — and we hope you have — you’re way ahead of most of the market. Developing a thorough trading plan (trade size; entry levels; and exit levels, both stop-loss and take-profit) while you have a clear head (no open market risk and its attendant emotional distractions) is the first step to actively trading in the currency market.
On the most basic level, every trade ends with either a profit or a loss. Sure, some trades finish flat, which is when you exit the trade at the same price you entered, producing no gain or loss. Most of the time, though, you’ll be dealing with the agony of being stopped out or the ecstasy of taking profit.
Taking profit is usually a positive experience for most traders. But if the market continues to move in the direction of your trade after you’ve squared up and taken profit, you may begin to feel as though you’re missing out or even losing money. This is where traders may begin to fear they’ve taken profit too soon. The emotional element can become very strong, and past trading experience can begin to color your current thinking. The alternative is usually not taking profit at all, which ultimately leaves you exposed to continued market risk.
The important factor to remember is that you took profit based on your trade plan, whether it was based on a technical level being reached or an event playing out. You identified a trade opportunity and went with it, so enjoy the fact that you’ve got something to show for it. And don’t get greedy. No trader ever captures 100 percent of any price movement, so keep your gains in perspective and remember: The market is not there to give you money. That’s why it’s called taking profit.
Also, avoid the urge to suddenly take a position in the opposite direction. If you were short and prices moved lower, for example, and your analysis and strategy have led you to buy back that short, you may be tempted to venture into a long position. After all, if you were right that prices would move lower, and you’re now buying back your position, it stands to reason that the market may begin to move up — otherwise, why would you be buying now? But this trade is another trade entirely and not the one you identified earlier.
One way in which traders are able to stay in the market with a profitable position and hang on for a potentially larger move is to take partial profits on the overall position. Of course, taking partial profits requires the capability to trade in multiple lots — at least two. The idea is that as prices move in favor of your trading position, you take profit on just a portion of your total position.
For example, you may have bought 15 mini lots for a total position size of 150,000. If prices begin to move higher, you may sell out pieces of the overall position, realizing profit on a part of your position, but hold on to the rest if prices continue to move in your favor. If prices reverse course, you’ve reduced your market exposure and you may still have a profit to show for the overall trade. If prices continue to rise, you can continue to take profit until your position is completely closed out.
As part of any trade strategy and to preserve your trading capital for future trading, you always need to identify where to exit a trade if the market doesn’t move in the direction you expect. Devote as much time and energy to pinpointing that level as you need, always keeping in mind that a lot of short-term price action can be stop-loss driven.
No trader is right all the time, so getting stopped out is simply a part of trading reality. Traders who apply intelligent and disciplined stop-loss orders occasionally may suffer setbacks, but they’ll avoid getting wiped out, and they’ll still be around to trade the next day. Traders who fail to use stops, or who move them to avoid having them triggered, run the risk of getting wiped out if the move is large enough.
The one type of stop loss that traders may actually enjoy seeing triggered is trailing stop-loss orders, which are often used to protect profits and enable traders to capture larger price movements. (We explain how trailing stop-loss orders work in Chapter 4.)
Trailing stops are no surefire guarantee that you’ll be able to stay onboard for a larger directional price move, but they do provide an element of flexibility that you should consider in adjusting your trade plan. For example, if your position is in the money and holding beyond a significant technical break level, you may want to consider adjusting your stop loss to a trailing stop that has its starting point on the other side of the technical level. If the break leads to a more sustained move, you’ll be able to capture more than you otherwise might. If the break is reversed, the trailing stop will limit the damage.
When you’ve identified a trade opportunity and developed a risk-aware trading plan, you’re going to have active orders out in the market to cover your position one way or the other (stop-loss or take-profit). Depending on your trading style and the trade setup, you can reasonably follow a set-it-and-forget-it trade strategy where your orders will watch the market and your position for you.
Medium- to longer-term traders are more likely to rely on set, or resting, market orders to cover open positions due to the longer time frame of such trade strategies and the burdens of monitoring the market overnight or for longer stretches of time.
Shorter-term traders are more likely to follow a more dynamic approach, again based on the shorter time frame of such trades. Short-term traders are more apt to be in front of their trading monitors or using their smartphone trading apps while their trades are still open, but they should always still have an ultimate limiting set of orders to cover the trade strategy.
Depending on the basis of the trade opportunity you’ve identified, there will be very real hallmarks indicating what, if any, adjustments you should make.
Trades based on fundamental events (like a data report or an expected monetary policy statement) have a very real basis in both time and content. If you’ve taken a position based on a data release, for example, when the report is issued, you and the rest of the market now have that information.
If you’ve anticipated various outcomes to the report, you’ll have a leg up on the market in interpreting the subsequent price action. If the market is not reacting the way you expected, it’s a strong sign that other forces are at work. The market reaction to the data or news is usually more important than the event itself.
In trading, it’s frequently said that timing is everything. Truer words were never spoken. But that line applies to trying to time your entry and exit to capture tops and bottoms in the market — market timing, in other words.
But we’re talking about the time on the clock on the wall. The time of day and the day of the week can frequently influence how prices behave and how your ultimate trade strategy plays out. If you’re trading ahead of major data releases, for example, you need to be aware that price action is going to be affected in the run-up to the scheduled release, not to mention in its aftermath. There’s no set way that prices will behave before data releases, but you still need to be alert to upcoming events that may dictate changes to your trade plan.
Similarly, if you’ve been positioned correctly for a directional price move in the New York morning, for example, you need to be aware that there may be a price reaction as European traders begin to wind up their trading day. Some London closes may see the price move continue in the direction it was going; other times, the price move may reverse. The question for you as a trader, though, is: Do you really want to find out which way it plays out?
Depending on the day of the week, you may be looking at different liquidity conditions (such as a holiday, a month end, or a quarter end, which frequently see lower liquidity and the chance for outsize volatility). If it’s a Friday, the market will be closing for the weekend in a matter of hours. If you hold on to your position, you run the risk of being exposed to weekend gap risk. Do you want to wait until the last minute and expose yourself to the uncertain price action?
When it comes to market information, the most reliable information is always the prices themselves. Sharp price reactions are usually strong indicators of significant market interest — interest that is either pushing prices faster in the same direction or repelling them in the opposite direction.
As you’re monitoring your position in the market, you need to be closely attuned to significant price reactions, such as spike reversals or price gaps, with a good benchmark being typically more than 20 points over a few minutes. The sharp move in prices may be due to news or rumors, or it may just be a pocket of illiquidity. Either way, the sharp price move carries its own significance that is information to you. There’s no set way such moves always play out, but if you’re alert for them, you’ve got one more piece of information to help you decide when and how to exit your position.
Active currency trading is as much a learning process as it is a speculative endeavor. Good traders learn from their mistakes and try to avoid repeating them in the future. Bad traders keep making the same mistakes over and over again until they give up in frustration or are forced to give up for financial reasons.
Successful trades also represent excellent learning opportunities, both about how different trading strategies work best and about your own personal response to them. Successful traders remember what they did right and try to emulate it in the future, knowing full well that no two trades are ever the same. Bad traders only remember that they won, but they fail to take the lessons of why they won to heart.
The best way to learn from each trading experience — both good and bad — is to make post-trade analysis part of your regular trading routine.
Regardless of the outcome of any trade, you want to look back over the whole process to understand what you did right and wrong. In particular, ask yourself the following questions:
Recollections of individual trades can be hazy sometimes. Some traders may tend to favor remembering winning trades, whereas others may remember only the losing trades. The only way to get to the heart of the matter is to look at the numbers — the results of your trades over a specific time period, such as a month.
A trading record doesn’t lie, but you still have to interpret it properly to glean any useful lessons from it. We find that depending on your trading style, it’s best to approach analyzing your trading record from two different angles, each with a common denominator — average wins and average losses.
Your results can be very helpful in allowing you to further identify your strengths and weaknesses as a trader. The main focus is to evaluate how good you are at spotting trades and how your financial successes compare to your financial losses.
If you have more winning trades or trading days per month than losing ones, you’re on the right track and you’re likely adept at spotting trading opportunities or actively trading in and out in the market. If your losing days or trades outnumber your winners, you probably need to take a good hard look at how you’re identifying your trades or making your short-term decisions.
Next, you want to look at the size of your average win and average loss. Again, if your average win is larger than your average loss, you’re doing something right, and that bodes well. When you’re right, you’re right for a larger amount than when you’re wrong — and that’s just the way you want it to be.
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