Forex Exit Strategy - 5 Things You Must Know

If you had to break a system down to it's various components, most traders will argue that the most important parts of a forex trading system, or any other kind of trading system for that matter, are its exit strategy and its money management.

Of course, the other parts of a system are also important, such as the entry rules, the instruments that are traded, and the time frames that are used, but the exit strategy in particular can really determine the overall success of a system.

What we're going to talk about in this article are the 5 things that you must know about forex exit strategies. If you understand these 5 points, you'll be able to much more quickly pick up the rules and skills when learning a new forex trading system.

Here they are:

1. Trailing stops are one type of exit strategy used in forex trading systems.

Their main purpose is to protect profits. They do this in 2 ways. Firstly they allow enough “room to breathe” so that minor fluctuations in the currency price will not stop you out of the trade, and therefore “allow profits to run”. This is important.

Secondly, they're trailed upwards in a long trade, therefore protecting your profits as the trade goes is your direction, but eventually exits you from the trade when the trade does go against you. In general, trailing stops do not go backwards (which for a long trade is back down), because if they did, they'll no longer be protecting your profits.

2. Initial stops are also important in forex trading systems.

The purpose of the initial stop is to get you out of the trade if the trade goes in the wrong direction near the beginning of the trade.

In general, many systems have both an initial and trailing stops, but the trailing stop may not be known until later in the trade, when say a peak or trough has formed thereby causing the trailing stop to be placed. That is, in some systems a trailing stop is based on price movements, and these technical points may only be formed some time after the trade is entered.

An ideal initial stop should allow “room to breathe” as well, but not so large as to cause the risk in the trade (the difference between the entry price and the initial stop) to be too large. If the risk in the trade is too large, then the trade sizes will be very small (assuming that you're using a fixed percentage risk model for your money management).

3. “Take profit” targets are another foex exit strategy.

Many forex systems exit positions either fully or partly, when a certain profit target has been reached, say at 50 or 100 pips. One reason why they're used in forex trading in particular, is that the volatility of the market can cause the prices to fluctuate and get you out at your trailing stop before you had a chance to take profit.

So these take profit targets are used, assuming of course that they improve the profitability or reduce the drawdown of the system, as determined by backtesting or forward testing the forex trading system.

4. Breakeven stops are another commonly used forex exit strategy.

If you enter a trade, and have an initial and trailing stop in place, and the currency moves in the direction of your trade, the trailing stops may be moved to breakeven, that is, to the same price or slightly beyond the entry price, when say the trade is “x” pips in profit.

The purpose of this kind of stop is again to improve profitability and to reduce drawdown.

5. Finally, realise that in forex trading, many systems will exit a trade within a certain amount of time before a major economic announcement.

A major economic announcement is an announcement that has the potential to cause a temporary but large move in the market accompanied by a sudden increase in volatility. This typically occurs if the economic figures announced are different to what the market expected. If this occurs, you may be taken out at your trailing stop and there may even be gapping, so it may be beneficial to get out at the current price, rather than being bumped out at your trailing stop when an announcement does make a dramatic move in the market.

In conclusion, you should now understand what these five different forex exit strategies are all about, and why they're used.

So when you're assessing a new forex system, put this into practice! See what kinds of stops are used in the system, and how effective they are.

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