How many times have you been in a trade that goes in your favor a decent amount of pips and then it starts moving against you and you start to feel panicked? What about being in a trade that is up a nice profit and you decide to close it out only to see the market continue moving two or three times further in your favor without you on board? Is this just “part” of trading or are there things you can do to limit these types of frustrating trading situations? Today’s lesson is going to explain how you can make exiting your trades as simple and unemotional as possible.
Exiting trades is hard for most traders, but it doesn’t have to be. Like most other aspects of trading, people tend to over-complicate their exits and make them a lot more difficult than they need to be. It is the exiting of a trade that truly does separate the winners from the losers in the trading world. There are some very talented market analysts out there who can pick the market direction with 80% accuracy but still cannot turn a consistent profit because they are terrible at exiting the market.
Change the way you think about trade exits
When you think about “exiting a trade”, the first thing that comes to your mind is probably not a stop loss getting a hit for a pre-calculated loss that you knew had about a 40 to 60% potential of taking place. Instead, you probably think more about “rewards” and “take profit levels” when you think about exiting a trade, at least this is what most traders tend to think about it.
It’s pretty normal to think this way, because after all, most of us are initially drawn to trading from the idea of “fast money” or “quick profits” and “rewards”…and so it takes more brain power and forward-thinking to force yourself to think about losses and stop losses getting hit as an equally important part of exiting trades. So, don’t think you are alone if you have a fixation on profits and rewards…just know that you will need to “shift” your mentality on exiting trades if you want to have a chance at making consistent money in the market.
An important fact to understand about exits is that an “exit” includes profit targets AND STOP LOSSES, and an exit can also be a breakeven exit. Thus, it’s important to start thinking about stop losses as a critical component to your overall trade exit strategy, because how you manage losses and risk will decide whether or not you make consistent money in the market.
Accept that you simply aren’t going to win some trades
I’m going to tell you something right now that will have a profound effect on the rest of your trading career IF you decide to believe it and build it into your trading and money management plan: YOU ARE GOING TO HAVE LOSING TRADES. Whether or not you want to accept this fact is up to you. But, if I can promise you one thing about trading, it’s that you WILL have losing trades. How you manage your losing trades is a critically important factor in determining whether or not you make money in the market.
If you feel like you have already mastered your trading strategy and you have patience to wait for it to provide you with high-probability entry signals (you aren’t over-trading), the only other way you can consistently lose money in the market is by mismanaging your exits.
Here’s the “behind the scenes” reason why so many traders find exiting trades difficult or otherwise mismanage their trade exits; they are risking too much money per trade.
Think about it; if you have over-leveraged your account on a trade and it goes into profit for you, you’re going to have a very hard time taking that profit because relative to your account size you have a large open profit and as you sit there looking at that large open profit all you can think about is how much more you “could” make. You begin to justify reasons of why the market “might” keep moving in your favor and start “counting your chips at the table” by calculating how much more profit you could make on the trade if it keeps moving in your favor.
Of course…you are probably all too familiar with how the story ends…you don’t take the open profit for the reason I just described, and the trade starts moving against you and you are almost paralyzed in disbelief at how fast all your profit is vanishing. Your thoughts then move to the idea that “maybe” the market will stop moving against you and turn back around in your favor. You are now on the “roller coaster” of emotional trading that will eventually end in you losing a large amount of money…all because you risked too much on the trade.
Simple solution: ACCEPT that you aren’t going to win every trade and act accordingly. “Accordingly” means that you never risk more than you are OK with losing on any one trade, because, like it or not you COULD lose on any trade you take, not matter how “sure” you feel about it.
You need to be flexible but not emotional with your exits
As traders, we have to constantly ask ourselves whether our next decision in the market is a purely emotional one or one supported by logic and by what the price action is actually showing us on the chart.
Perhaps one of the most common mistakes that traders make in exiting their trades is moving their initial target further away ONLY because they think the trade will keep going in their favor. Most of the time, doing this leads to a smaller profit than what you had originally planned, or no profit at all.
Note: Just to be clear, I am NOT saying that you should never move your target further out from your entry or that you should never intervene and close your trades out manually, because if there’s a price action-based / objective reason to do so, then you should. The question you have to answer about profit targets is are you moving your targets around or exiting manually based on emotion (greed or fear), or is it based on what the actual price action is doing on the chart?
Remember, when you originally plan your exit for the trade, you place the profit target based on your mindset and analysis of the market just before you entered. You were probably a lot more objective and calm at that time because you weren’t in the market yet. Once your trade gets filled you immediately become less objective and more emotional as the market ebbs and flows. The best course of action in regards to profit targets, is often just to leave it where you initially planned it. Moving it further out as price approaches it is typically an action born out of greed…not out of logic. How many times have you done this and then the market hits your initial planned target or moves just a tiny bit past it and then rockets back against you, turning a solid open profit into a much smaller one or even a loss?
Even if the market DOES keep going in your favor after you moved your target further out, it’s still a bad habit to develop because it means you are reacting emotionally to what the market is doing rather than preempting your actions in the market and acting objectively. You cannot rely on luck in trading, eventually your luck will run out, probably when you need it the most. Thus, essentially what I’m saying here is that you need to stop moving your profit targets away only because the market is getting close to hitting them. Let them get hit if there’s no price action based reason not to move them; let your pre-planned profit target play out, then patiently wait for the next trade. This is part of developing discipline, patience and the correct trading habits.
You also need to be flexible but not emotional with your stop losses. You can be a little bit more rigid with stop losses than with profit targets. Meaning, with stop losses, it makes more sense to let the market take you out by moving down or up into your stop loss, that way you give the trade the maximum possible chance of moving in your favor.
The “set and forget” trade management concept that I teach is more important in regard to stop losses than profit targets. We need to avoid exiting a trade just because it’s going against us; we need to be much more disciplined with the set and forget concept by not exiting until our stop loss is hit in most cases.
If you manually close a trade out for a loss before it hits your pre-determined 1R dollar loss, you are also voluntarily eliminating any chance of the trade moving in your favor and this obviously affects the potential long-term profitability of your trading strategy. This is OK to do sometimes, IF the market’s price action calls for it, but a lot of times traders close out trades for small losses ONLY because the market moves against them a little bit, then the market moves back in their favor without them on board. As with profit targets, you really should only move a stop loss or close a trade out manually for a loss if there’s a valid price action based reason to do so.
Note: You should NEVER move your stop loss further away from your entry point, no matter what. This is like the cardinal sin of trading and it’s a fast track to blowing out your account. Stop losses should only ever be moved to reduce your risk on the trade, to breakeven or to lock in profit by trailing the stop.
Sometimes, taking a smaller profit is OK…
This point goes along with what we just discussed about being flexible in your trade exits. But, I wanted to mention this more in-depth since I know there are some misconceptions out there about taking less than a 1:2 risk reward and when / if that’s “OK”.
Basically, you don’t need to be totally “rigid” by always either taking a 1:2 or 1:3 risk reward (or some other pre-set reward) or no reward at all. Sometimes, it does make sense to close a trade out with a smaller profit if there’s price action telling you to do so…even if you haven’t reached a 2R or more profit.
I get emails from traders saying things like, “Nial, my trade came 5 pips shy of a 1:2 profit today but I didn’t take it and it turned around and now is at a loss”…this is where you need to monitor your trades and intervene if you have to. If the market gets really close to your profit target you should monitor the price action, if you are at a 1:1.5 or 1:1.8 risk reward and the market appears to be turning around (based on the price action)…there’s nothing wrong with closing the trade out and taking the profit off the table. You don’t need to let profits slip away just because you are trying to get some exact profit target, that’s also being greedy…situations like these is where the saying “don’t be a dick for a tick” came from.
You want to keep an eye out for a price action signal that is opposing your initial trade or for situations where the market spends a long time trying to touch a level but can’t quite get the legs to hit it. If you notice either of these things happening it probably means you need to intervene and possibly exit the trade early.
Set and Forget truly is powerful, use it with discretion though.
Many of you have probably already read my ‘set and forget trading’ article that talks about a very simple trade management technique which, as the name implies, involves setting and forgetting your trades. In other words, after you enter your trades you don’t meddle with them. However, there are exceptions to this rule, because the markets are dynamic and constantly changing…so we cannot afford to be 100% rigid in our approach to trading.
It will help if you think of “set and forget” as more of a “default” trade management technique…not something you do all the time despite what the market is telling you. Set and forget basically just means you don’t do anything if there’s nothing logical to do. It should be your baseline trade management point…meaning, after you enter a trade you don’t move your stops or targets around unless the price action that you see on the chart is implying that you should. You should consider “set and forget” as a nice metaphor for managing your trades with logic and objectivity instead of emotions like fear and greed.
Thus, the mental concept of “set and forget” is important, but the actual practical implementation of it will still require some monitoring and intervention. You will need to monitor your trades say once every 4 to 8 hours on average, and at the time you need to be as objective as possible as you observe the market. If a trade is working as planned, then do nothing. If the market has formed a huge pin bar reversal against your position but you are still up about two times your risk…then it probably makes sense to close that trade out manually and take the profit, because you have a valid price action-based reason to do so.
However, let’s say you check in on your trade and it’s gone against you by 20 pips but there’s no obvious price action telling you to exit. You would not close the trade at that point, you would instead leave it open and just let the market play out. Closing a trade only because it has gone against you a little bit is not a good enough reason to close it out…we need to give our “edge” (trading strategy) time to play out if there’s no logic / price action-based reason to close it out.
What is a “successful” trade exit?
Finally, you can determine whether or not you exited a trade successfully by answering the following questions:
1) Did I exit emotionally or logically? (“Logically” should be the answer)
2) If I lost on the trade, did I lose my predetermined dollar risk amount (1R) or less? (“Yes” should be the answer)
3) If I won on the trade, did I make 2R or more on the trade? If I made less than 2R on the trade is there a logic and price action-based reason that I exited before 2R was hit or did I just panic because the trade was moving against me? (“Yes” you should have exited logically no matter the size of your profit)
If you want to learn more about learning to read the market’s price action to help you exit trades simply and successfully, checkout my trading course and members’ community.