Setting the Exit Point

Where to Set the Exit Point in your Forex Trading

Following up from our article on how to set the entry point for a trade, we now talk about the other half of the equation, which is on how to set the exit point. In setting the exit point, only two factors must be considered.

a)    Support and Resistance Areas

b)    Recognizing when to exit a trade

Some persons reading this may find these considerations strange. But the fact is this: trade exits are not always set in stone. There will be times when your trade will go on to achieve great things by delivering the expected reward for the risk assumed, but there will be other times when a trade which is decidedly not going to end as expected may have to be rescued by either exiting with minimal loss or use a trailing stop to protect any small profits gained.

So let us start the discussion of how to set the exit points for trades that are either going well, or expected to go well. For these trades, two key metric to consider would be the risk-reward ratio, and the support/resistance areas found on the charts.

The Role of Support and Resistance in Trade Exits

A good trade is one in which there is more reward than risk, with other risk management parameters being applied to the letter. The risk-reward ratio simply refers to the proportion of risk applied to the trade (by the stop loss) to the reward desired from the trade (the Take Profit point).

Experts generally prescribe that in a worst case scenario, a trader should aim to make at least 2 pips for every 1 pip risked in the stop loss; a risk-reward ratio of 1:2. By extrapolation, it means that for the number of pips set by the trader as stop loss, the trader should multiply this by at least a factor of 2 to get a good risk-reward ratio.

But is it a wise thing to do to simply assign figures to the risk (stop loss) and the reward (take profit)? The truth is very far from it. The first principle in setting the exit point (i.e. the reward point or the Take Profit level) is to ensure that this level does not go beyond the most immediate key level of support or resistance which will limit its move. In other words, a trader who is long on a currency pair should not set a Take Profit point above a strong resistance, while a trader who is in a short position should not set a TP below a strong support. If this is done, then you can be sure that the trade will be rejected at the key level.

To illustrate this, look at this chart below:

exit point 1

You can see that the price moved from the trade entry level at R1, broke the central pivot and hit the next support level at S1. However, the price action failed to break this level and retreated back to the central pivot. Supposing the trader had gotten greedy and decided to push his luck by setting the Take Profit below S1, what would have happened? The TP would never have been hit, and a potential profit of 1,670 pips would have ended up shedding at least half that value. That would have been very painful.

Never break this rule. Your reward setting should be within the context of making sure that the TP level is set at rational and functional limits. Do not stretch your luck too far.

Knowing When to Exit a Trade: Reversal Factors

Knowing when to exit a profitable trade would also incorporate knowing how to use support and resistance points to set exit points as depicted above. However, support and resistance alone will not always be the criteria used in exiting trades. This is where reversal factors will come in. By reversal factors, we mean the following:

a)    Reversal candlestick patterns

b)    Reversal chart patterns

c)     Indicators

The appearance of reversal candlesticks after a major move should not be ignored. They may be a sign that the market is about to reverse as shown here:

exit point 2

See the sustained major uptrending price action on the left side of the chart, which was abruptly truncated by the appearance of two pinbars, which are potent signs of a market reversal. Not too long after, the price of the currency pair underwent a complete retracement. Any trader who ignored those pinbars would have been in for a long day.

Certain indicators can be used to predict exit points. For instance, the Fibonacci Expansion tool can be used to set the exit points of Fibonacci retracement trades.

exit point 3

In this snapshot, we can see that the Fibonacci Expansion tool (in dotted red lines) has clearly shown a short trade exit area (lower purple line), and the price action underwent a total reversal not too long after. Trying to push one’s luck by setting ambitious profit targets which are much lower would have ended in disappointment.

Conclusion

Exit points must not be set in an arbitrary fashion. They have to be set rationally using the guidelines described above. It is only when this is done that traders will stop suffering the mishap of losing pips that should have been won back to the market.

Adam

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Adam is an experienced financial trader who writes about Forex trading, binary options, technical analysis and more.

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