Chapter 16

Closing the Position and Evaluating Your Results

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!

In terms of maintaining a positive trading attitude, you have to accept that you won’t be right all the time, so why should you kick yourself when a trade doesn’t work out? The answer is, you shouldn’t — unless you failed to actively plan and monitor your trades. If you didn’t do that, you have every reason to blame yourself.

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.

Closing Out the Trade

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.

Taking profit and stopping out

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 too soon or not at all

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.

Above all, avoid making rash trading decisions after you’ve taken profit. The market may continue to move in the direction of your earlier position, and you may be tempted to reenter the same position. In some cases, reentering the same position may be the right thing to do, but until you reevaluate the market objectively and without the emotional baggage of previously being right (but not as right as you could’ve been), you run the risk of overstaying your welcome.

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.

Treat each trade independently, and recognize that the outcome of one trade has no bearing on the next trade. Instead, take a step back and reassess the market after you’ve regained the objectivity that comes from being square.

Taking partial profits

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.

Whenever you’re taking partial profits, you need to modify the size of your stop-loss and other take-profit orders to account for the reduction in your total position size. Some online brokers offer a position-based order-entry system, where your order size automatically adjusts based on any changes to the overall position.

Depending on the jurisdiction in which you’re trading, closing partial positions may be treated differently. In the United States, forex providers are required to account for your trades on a first-in, first-out (FIFO) basis. For example, if you buy one lot at 30, one at 20, and one at 10, you’re long three lots at an average of 20. When you close out your first lot, you’re going to be selling the one you first bought at 30. In most other jurisdictions, you’re able to choose which individual lot you want to close.

There’s no practical difference on your margin balance between the two, but some traders like the idea of closing out the lots with the most profit. The key here is that you’ve averaged into a position, and the market needs to reverse beyond your average for you to realize a profit under either system. If you take profit only on those lots that are in the money, you’re still exposed to a loss from the ones that remain out of the money. If the market never fully reverses, it means it’s still moving against you, and you’ll need an exit strategy.

Stopping out before things get worse

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.

Anticipate that key technical and price levels will be tested to see if stop-loss or market orders are there. Testing levels is what trading markets spend a lot of time doing. For this reason, we like to factor in a margin of error in placing our stops, based on the individual currency pair and the current market environment. (We discuss the pros and cons of applying a margin of error for stop-loss orders in more detail in Chapter 13.)

In our experience, no one is ever happy when a stop-loss order gets triggered. The fact of the matter is that stop losses are a necessary evil for every trader, big and small. You never know beforehand where a price movement will stop, but you can control where you exit the market if prices don’t move as you expect. Most important, stop losses are an important tool for preventing manageable trading losses from turning into disastrous ones.

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.

Trailing stop losses for larger price movements

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.

Setting it and forgetting it: Letting the market trigger your order

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.

Remember to use rate alerts to update you on specific price movements (see Chapter 15). The archetypal picture of the currency trader sleeping with a phone under the pillow is not really that far off. Depending on how your trade is developing, you can make order adjustments typically in a matter of seconds or minutes and get back to sleep (or whatever it was you were doing).

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.

You may want to be flexible with where you leave your take-profit order, but always have a stop-loss order in place to protect you in case of unexpected news or price movements. If you’re trading the market from the long side (meaning, you think prices in a currency pair are likely to move higher), you need to pinpoint the ultimate price level on the downside, which negates this short-term view.

Squaring up after events have happened

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.

Most important, though, is that the basis for your trade strategy — the event — has taken place. If the market doesn’t react as you thought it would, you have very little reason to continue to hold onto the position. Always relate your original rationale for holding your position back to the reality on the ground. When events turn out differently from what you expected, start looking for the exit sooner rather than later.

Exiting at the right time

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?

At the minimum, you may want to make adjustments to your trade strategy to limit any negative impact from session closes, such as reducing your position size, tightening stop losses, or squaring up altogether.

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?

Staying on top of the time of day is as important a trading consideration as having the right position. When it comes to adjusting your trading plan or closing out your position, it frequently pays to be a clock-watcher.

Getting out when the price is right

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.

If the rapid price movement was in your favor, you can look at it as a new high-water mark, or as a new support or resistance level. If the move is reversed, the tide is reversing, and you should consider exiting sooner rather than later. If the tide doesn’t reverse, you’ve got a solid short-term price level on which to base your decisions going forward. If the price move was against you, you may want to consider that the market is not cooperating and adopt a more defensive strategy, such as tightening stop losses, reducing your position, or exiting altogether.

Assessing Your Trading Strategy

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.

Identifying what you did right and wrong

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:

• How did you identify the trade opportunity? Was it based on technical analysis, a fundamental view, or some combination of the two? Looking at your trade this way will help identify your strengths and weaknesses as either a fundamental or technical trader. If more of your winning trades are being generated by technical analysis, you’ll probably want to devote more energy to that approach. If more of your winning trades are coming from the fundamental approach, you’re probably better off concentrating on a fundamental style.
• How well did your trade plan work out? Was the position size sufficient to match the risk and reward scenarios, or was it too large or too small? Could you have entered at a better level? What tools might you have used to improve your entry timing? Were you patient enough, or did you rush in thinking you’d never have the chance again? Was your take profit realistic or pie in the sky? Did the market pay any respect to your choice of take-profit levels, such as stopping short of it, or did prices blow right through it? Ask yourself the same questions about your stop-loss level. Use the answers to refine your position size, entry level, and order placement going forward.
• How well did you manage the trade after it was open? Were you able to effectively monitor the market while your trade was active? If so, how? If not, why not? The answers to those questions will reveal a lot about how much time and dedication you’re able to devote to your trading. Did you modify your trade plan along the way? Did you adjust stop-loss orders to protect profits? Did you take partial profit at all? Did you close out the trade based on your trading plan, or did the market surprise you somehow? Based on your answers, you’ll learn what role your emotions may have played and how disciplined a trader you are.

There are no right or wrong answers in this review process. Just be as honest with yourself as you can. No one else will ever know your answers, so you have nothing to lose by being candid. On the contrary, you have everything to gain by identifying what you’re good at, identifying what you’re not so good at, and understanding how you should best approach the market.

Updating your trading record

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.

• Long-term and medium-term traders: Tend to have fewer overall trades because they’re more likely to be looking at the market from a more strategic perspective, picking trade opportunities more selectively. If that’s you, you’ll want to tally your results on a per-trade basis, totaling up separately the number of winning trades and the number of losing trades, along with the total amount of profits and the total amount of losses. Divide the number of profits by the number of winning trades to find your average winning trade amount. Do the same with your losing trades.
• Short-term traders: Tend to have a larger number of trades due to their short-term trading style. If that’s you, you’re going to want to measure your results on a per-day basis. Tally up your daily profit and loss (P/L) and note the number of winning/losing days in a month, along with the average win/loss per day.

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.

Focus on what you’re doing right, but also figure out what you’re doing wrong. Refine your analysis of your trading results by breaking them down to smaller categories, such as day of the week and currency pair or even trade size. Are your losing days or trades concentrated on certain days of the week, such as Fridays or Mondays? For example, in our own experience, trading on the last day of a month was a losing proposition. Are your losing trades concentrated in certain currency pairs? Does the position size of each trade have any relationship to wins and losses? Are you winning more on large trades, for example, or are you giving up larger losses on smaller trade sizes?

Look at your results as dispassionately as possible. They’re the real reflection of your currency trading. Learn from them, and use them to do the following:

• Keep yourself honest. You may remember only the winning trades and not realize you’re developing bad risk-management habits.
• Spot dangerous habits or lapses. Over time, you’ll develop and refine your trading style. If you’re successful, you’ll want to stay that way, and monitoring your trading results on a regular basis is the way to do that. If you lose more than you normally do on a losing trade, you may want to consider scaling back. If you’re winning on more days or trades than normal, you’ll also want to do a reality check and make sure you aren’t overextending it.
• Be your own best teacher. Identify your strengths and weaknesses, as well as trading styles and market conditions that fit your temperament and discipline best. Focus on those where you experience the greatest success, and avoid those with bad results.
• Identify market sessions and currency pairs that suit you best. Interpret your trading results to help pinpoint currency pairs where you’ve had the most success and avoid those where you don’t. You may need to adapt your trading schedule and concentrate on only a portion of a particular trading session.

Currency trading is all about getting out of it what you put into it. Evaluating your trading results on a regular basis is an essential step in improving your trading skills, refining your trading styles, maximizing your trading strengths, and minimizing your trading weaknesses.