By Sean Hyman Through the years, traders have told me that they usually know when to enter a trade but have no idea when to exit a trade. So let’s talk about that for a moment.

The way I see it, there are a few main ways that traders form their exit strategies. One of the simplest approaches is to simply draw trend lines (angled lines) or support/resistance lines (horizontal lines) on the charts. Then traders simply exit their positions when a particular pair breaks through these trend lines.

This is one of the simplest ways to form your own exit strategy. For instance, say you were riding the uptrend below (blue line) with one of your trades. You would stay in that particular pair until the trend line broke (yellow boxed area).

After that, you could either exit the trade altogether, or perhaps you might decide to short that pair and ride the downtrend (red angled line). If so, you would do the same thing: Stay in that pair until the trend line broke once again (yellow boxed area).

Let the Lines Decide For You!

You see, these aren’t just lines. They are ways to measure the supply and demand for a currency pair. The uptrend is broken because there are fewer buyers for that particular pair in the market. It can also mean there is an increase in sellers. As a result, the uptrend breaks down. The inverse is true for the downtrend.

You will also see above, areas of support/resistance where the pair just ranges sideways between those support and resistance areas. In this case, you can buy near former support (lower pink box) and your exit could be at the former areas of resistance (wide upper pink box).

So these are simple ways to exit out of a trending market and also a sideways ranging market. However, once you’ve gotten this simple approach down, it’s good to move on to other aspects of the exit strategy, which have to do with gauging your own personal risk in your trading account.

Double the Reward, with Less Risk

Why go into a trade unless the risk is justified? For instance, say I can enter a Forex trade with 100 pips of potential upside before the pair hits resistance. If so, then I could place a stop 50 pips away from my entry. All of the sudden I can potentially gain twice as much as I’m risking out of my account.

Double the reward vs. the risk makes the trade worthwhile.

To do this, you need to analyze what’s called the “risk to reward” on the trade. You need to look at exactly how much cash you’re risking on each trade for what potential reward. For example, say a particular pair only looks to gain 10 pips tops. But you have to risk 20 pips on the trade in order to gain the 10 pips. In this case, it’s probably not a risk worth taking.

To find out how far a pair can move, you need to analyze how far the present price is away from its next major resistance level. Then you compare that to what you are willing to risk on the trade. Using that system, you can quickly see if the trade is worth the risk to you.

So, I’d call this the next level of managing risk to your account. However, let’s talk about one of the best gauges to quantify your risk in a trade, the ATR (Average True Range indicator).

Check out the chart below and you will see the ATR indicator plotted below it. This tells us how many pips the pair is moving “on average” each day.

ATR Becomes Your Friend When Measuring Risks!

For instance, let’s just look at the daily, 1-year chart of the EUR/USD pair.

Last August, this pair was only trading an average of 120 pips a day. Just four months later, it over twice as volatile, trading an average of 300 pips a day of movement. Yet, if you fast-forward to today, the pair averages around 219 pips a day.

Different Volatility Forces You to Adjust Your Stops and Trade Fewer Lots

This is good to know. Why? Well, a 50 pip stop when the pair moves an average of 120 pips a day is one thing and a 50 pip stop when the pair moves about 300 pips a day is a whole other animal.

You see, the 300 pip day moves can knock out a 50 pip stop with ease. However, it’s much more difficult for a pair to knock out the same 50 pip stop just months earlier when the pair was moving only 120 pips a day.

So the more volatile the pair becomes, the wider your stop needs to be. This also means you need to decrease the number of lots that you’re trading to risk the same amount of your trading account on that one trade.

Savvy traders note the volatility and adjust their lot size and stops accordingly. They ratchet down their lot size quite a bit when the 300 pip days are in full swing. However, they may take it back up a notch when things settle down to only moving 120 pips a day since the volatility is more than cut in half off of its highs.

Now, the pro puts all of this together. He looks at the ATR and knows that if the ATR on the EUR/USD pair is trading 120 pips a day and he wants a 120 pip stop, then he knows he’s looking for a 240 pip profit over the coming days too. That way the risk becomes worth taking.

So he looks 240 pips up on the chart to see if it looks practical. In other words, can the pair move that much to the upside before hitting some upside resistance levels? If so, then the trade is worth taking. If not, then they pass and move on to another pair that has a better risk to reward to it.

This is how pros gauge their risks. So if you do the same, you may end up a pro one day as well!

Best Regards,

Sean

P.S. My colleague, Jack Crooks includes a profit target in every single trade he recommends to his Exotic FX subscribers. This way, his loyal readers know exactly how long they plan to stay in a trade before they call their brokers. But a word of warning: This is a fast-moving service, only designed for traders who are comfortable going for the really big gains in the Forex market. Does this sound like you? Then I invite you to click here and learn more.

Sean Hyman, “Professor FX” and Long-Time Currency Analyst Explaining How You Can Succeed in the Currency Markets.
Sean Hyman spends his days teaching his fellow professionals in the industry how to trade the $4 TRILLION currency market. Now he brings his 15 years of financial experience to you. From long-term currency strategies, to quick FX-trading moves usually reserved for the professionals, Sean will tell you everything you need to know to succeed in the currency markets.