Updated from its original posting on 2013-07-05
Traders tend to focus a lot of their time and energy on their trade entries. In fact, if you browse through online communities and forums, you’ll notice that majority of trade discussions revolve around entries.
But while it’s very important to know how and when to enter a trade, it’s equally crucial to know when to exit. Most people have a detailed plan and set rules on how to enter the market, but newbie traders often overlook the importance of having an exit strategy.
In this week’s edition of Pipsychology, I’ll be sharing a few tips on how to develop your exit strategy.
“Begin with the end in mind.”
Even before you enter a trade, you should already have your exit strategy laid out. Ask yourself the following questions:
1) How much are you willing to risk?
We here at BabyPips.com believe that risk management is one of the most important aspects of trading. To make money (and avoid losing money), you have to learn how to manage your risk. That’s how you separate traders from gamblers.
You should ALWAYS know how much of your account you’re putting on the line. Make sure that you only risk an amount that you’re comfortable with losing.
2) Where will you cut your losses?
Proper stop loss placement can make or break your trade, so it’s something you should consider even before you jump into the market. Make sure you place your stop loss appropriately and give your trade enough room to breathe.
For tips on how to set stop losses, check out the School of Pipsology’s lesson on chart stops.
3) What events may invalidate your trade?
To say that the markets are unpredictable would be an understatement. Unforeseen events always pop up and they often spark a ton of volatility.
However, there are those which we already know about. Economic reports and speeches by key officials are usually scheduled ahead of time. Their outcomes tend to affect markets in the same way that unforeseen events do. So why not prepare for them?
Always know what the market consensus is and the kind of behavior and reaction you should anticipate. Make contingency plans for when an event comes out differently than expected. Most importantly, be prepared to make adjustments to your trade when necessary.
4) How long do you plan to hold the trade?
For the record, you don’t necessarily have to set a time limit for your trades. However, it’s good to set expectations on how long you will keep it open.
Long-term traders, for example, may hold their trades for weeks, months, or even years. Usually, their trades depend more on fundamental factors that affect markets for a longer period of time. Being conscious of the time would help a swing or position trader keep track of market conditions.
Meanwhile, short-term traders can benefit from this practice in helping them assess whether a trade idea is still valid or not. Perhaps the consolidation on a particular pair has been going on longer than expected and it may be better to just close your trade early.
As you can see, young Padawan, exiting a trade is just as important as pulling the trigger, so put the same amount of time and analysis into it. Having a detailed exit strategy will not only keep you from making impulsive trading decisions and keep your emotions in check, but it can help you manage your risk and stay profitable in the long run.