The profit taking strategy is an extremely important factor in the trading process. You make money only when you close the position and earn your profit. Most traders don’t know when to exit trades properly. They either take profits either too early or too late. Ignoring the importance of a profit taking strategy subjects traders to magnified losses.
Profit Taking Strategy
A profit taking strategy defines what exactly a trader should exit a trade to realize maximum profits. Sometimes, it is also used to cut losses early. This is why it is also known as an exit strategy. Most traders do not follow a take profit strategy claiming that they will exit when they make enough money. The problem with the forex market, or any financial market, is there’s nothing as “enough money”.
Without a profit taking strategy in place, a trader can fell in the trap of emotional trading. This is because the market can generate emotional responses like greed expecting the market to be in the trade’s favor for long. But in such dynamic markets, trends can change in the blink of an eye.
In forex trading, timing is everything. If you enter a position too late, you will miss out profits. The same applies when you exit a trade in a wrong timing. If you exit too early, you will leave a lot of money on the table. But if you hold on too long, you might lose your gains. So, establishing a solid exit strategy will ensure you stick to preset rules, enhance your trading performance and keep you on the right track.
A take-profit (TP) order is set to close a trade when the price reaches profit levels. It is also an automatic order that doesn’t need your interference to be activated. While the stop loss basically aims for stopping losses, the take-profit order is intended for keeping profits.
Developing a Profit Taking Strategy
In order to create a proper profit taking strategy, you should understand your trading strategy first. Knowing what type of a trader you are and which style do you follow is very critical. Having a well-defined trading plan provides a guidance in the middle of the trading process, which is so helpful especially for beginners.
There are different trading strategies including swing trading, day trading, scalping and position trading. You just need to know which category you belong to.
- Scalping: This strategy suits trader who prefer short-term, or those who like to seize instant price movements. Forex scalping strategy focuses on accumulating small but frequent profits and trying to limit any possible losses. Despite the fact that these short-term trades would involve few pips price movements, when combined with high leverages, it can lead to significant losses if not executed carefully. So scalping is a short-term trading strategy that involves taking multiple small profits in a considerably short time.
- Day Trading: It is another short-term strategy that includes holding trades during a particular trading session. Day traders do not take overnight positions and close all trades each day which typically reduces exposure to market movements when the trader is inattentive to the market. Although it is applicable in all markets, the day trading strategy is mostly used in forex trading.
- Position Trading: This is a long-term trading strategy. Unlike scalping and day trading strategies, the Position trading strategy is primarily focused on fundamental factors. This strategy does not consider minor market fluctuations as they won’t affect the broader market trend. Position traders monitor central bank monetary policies, political events, and other fundamental factors to identify price trends. This trading strategy is more suitable for patient traders as trades may take weeks, months, or even years.
- Swing Trading: This one is for traders who prefer a mid-term trading style where positions can be held only for several days. It is based on the idea of making a profit out of changes in price, by identifying the swing highs and swing lows in a trend. For this strategy to be successful, price movements need to be carefully analyzed in order to identify when to enter and exit the trade. Although this strategy saves time by not having to closely watch markets during the day, it does leave you at risk of any disruption that may occur overnight, and sometimes price-gapping.
Top Profit Taking Strategies
1. Support and Resistance
A support level is where the price tends to find support and reverse to the upside. It is a price level at which the price is more likely to bounce off rather than continue falling. However, by breaching this level, the price is likely to continue falling until the next support level.
A resistance level is where the price tends to find resistance as it rises, and is most likely to reverse to the downside. It is the opposite of a support level. It means that the price is more likely to retreat from this level rather than break through it. By breaching this level, it is likely the price will continue rising until the next resistance level.
In long positions, traders place take profit below the nearest resistance level while setting the stop loss above the nearest support level. While in short positions, the take profit is selected above the nearest support and stop loss is placed below the resistance level.
2. Candlestick Patterns
Candlestick patterns are price patterns that are formed over time and believed to have a repetitive nature. It means that these patterns are repeated every while and reflect the emotional reaction of the traders to the prices. They are used to recognize a trend continuity or reversal by reflecting the buying and selling forces.
In Forex, candlestick patterns help traders identify trend reversals and breakouts. They are more useful when combined with technical analysis to select entry and exit points.
3. Fundamental Based Exits
In times of unexpected events and major news, financial markets tend to act in a surprising way. In some cases, this is a good reason to exit your trade manually. For example, a surprising central bank rate decision may push the market against your position. Other events may include political changes, fiscal or monetary decisions and big data release like inflation and GDP.
4. Trend Trading
The trend is the general direction in which the market price of an asset moves. Trends are categorized into three types:
- Uptrend (Bullish)
- Downtrend (Bearish)
- Horizontal (Sideways)
Basically, traders will enter long positions when the price trend is getting up and sell when prices are getting lower. Also, waiting for a trend reversal to enter the market is very common. Eventually, any price trend will come to an end. Trend lines and moving averages are used to detect a price trend. Moving averages help in identifying the continuity of a trend. Usually, traders enter long positions when a short-term moving average crosses above a long-term moving average and vice versa.
5. Price Divergence
Divergence is when the price is moving in the opposite direction of a technical indicator like RSI, oscillator or MACD. It is a very powerful signal in forex technical analysis and can efficiently signal a price reversal.
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