What is the hardest decision you have to make on any given trade? If you said the trade exit, you are correct and if you’ve traded for any length of time, you already knew that was the answer.
Over my years of trading the market and helping traders, I’ve gained a lot of experience and insight into how best to manage and exit trades, and today I’m going to share some of that with you.
To be clear, ‘trade exits’ means managing your stop loss and profit target as the trade unfolds. This can be a very tricky topic to tackle, because it is ‘tricky’ in reality, to put it nicely, as you probably already know. So, let’s dive into what I consider to be the best way to exit your trades after they are live in order to maximize profits and minimize losses…
Why are trade exits so difficult?!
Mentally, people make trade exits much more complicated than they ever need to be. They give into greed, they freak out and close trades out prematurely, they don’t give them time to work out, they don’t have a plan etc. These are some of the reasons why trade exits are hard for most people. The two most important things to realize, and what many traders have a lot of trouble accepting, is the following…
1. You are NEVER going to get EVERY pip out of a trade. Meaning, you aren’t going to squeeze every last pip of profit from a trade. So, aim to take ‘chunks’ of profit, not the whole thing, because that is being greedy. Remember the old saying; “Bulls make money, bears make money, but pigs get slaughtered”, it’s so true.
2. You are going to have to take losses sometimes, that’s just part of the game. Many traders, especially beginners, get caught up in a game of trying to ‘avoid’ losses. They do this until they blow out their accounts enough times to eventually realize they are going to have to accept losses are part of the trading game and develop a plan to deal with them properly.
Also, you are going to have change your idea of a ‘successful’ trade exit. If you take a loss on a trade, as long as it was your predefined 1R risk amount or potentially less, I consider that a successful trade exit. In short, a successful trade exit is one that was not an emotion-induced exit and that can mean a loss or a win.
OK, so trade exits are hard, what are you going to do about it? Cry about it? Give up? I hope not! I’m here to help you, so let’s get this stuff figured out….
The ‘2R’ trade exit plan…
I’ve developed what I call the ‘2R’ trade exit plan and in my opinion, if you follow it, it will help you make money over a series of trades in the market. Let’s talk about the logic and reasoning behind the 2R trade exit plan, exactly what it is and how it will help you become profitable.
Here’s how it works:
Now, here is where you need to pay close attention; over my 15+ years as a trader I’ve figured out that the best and most likely to be obtained risk reward ratio on average, is 2R. That is the ‘magic’ number you need to aim for, 2R. Now, understand that I am talking about using this trade exit plan with my price action trading strategies with a focus on higher time frames, this is assumed.
Also, this doesn’t mean you will always take a 2R profit, it means that close to 2R or more is your goal on every trade, because anything less than about a 2R profit and it becomes increasingly difficult to make money consistently over the long-run. There may however, be times when taking slightly less than a 2R profit makes sense, if there is a very obvious price action change against your position for example, but first, I want you to learn this way of exiting trades…
Here is the simple 2R trade management / exit plan broken down into 4 steps for you:
1. Determine your 1R risk on the trade. Don’t exceed this dollar amount.
First, if you don’t know what I mean by R or a trades ‘R value’, you need to read this. To review quickly, the R value of a trade is the risk you put on the trade, specifically the dollar risk. So, if you are risking $100 per trade for example, 1R is $100. We can then measure a trade’s potential reward in terms of risk, this is called risk / reward or risk to reward ratio. So, a trade with a 2R potential reward has a reward / risk ratio of 2 /1 or 2R; we are earning 2 times 1R on a 2R winner.
Next, you start every trade by determining what your 1R risk is. I can’t do this for you, so don’t email me asking or I will just tell you this…you need to determine the dollar amount you are comfortable with losing per trade, because remember that ANY trade CAN potentially lose, and if you don’t understand why, then read my article on the random distribution of winners and losers in trading.
2. Determine stop loss placement and position size
Determine the safest and most logical stop loss placement. Remember to give the trade room to breathe and that trades often take longer to play out than we think. Don’t be greedy and put a tight stop loss on the trade just because you want to make more money. Over the long-run this will actually cause you to LOSE, not make money. Once you know your 1r dollar risk and your stop loss distance on the trade, you need to calculate the position size or number of lots you can trade to stay under your 1R risk.
3. Calculate the 2R risk / reward level
Once you’ve determined your 1R risk amount and place your stop loss properly, you can find the potential risk / reward on a trade, and my risk reward calculator can help you do this. The most important number is 2R. Look to see if, based on surrounding key support and resistance levels, a 2R reward or better is realistically possible. Most of the time, it will be, unless a very obvious / key support or resistance level is close to your trade entry.
At this point, you also need to decide if you will place a profit target at the 2R level so that you are automatically taken out at a 2R profit OR if you will attempt to let the trade run to a 3R profit or greater. I recommend only aiming for more than 2R in obviously trending markets.
4. Now, here is the key: Once your trade is live, you do not move your stop loss from its predefined position until or unless the trade moves past a 2R profit.
At the point of obtaining a 2R profit you have two decisions to make, and this is where you must use your gut feel and personal discretion (you’ll get better at this over time). Depending on market conditions you either exit at 2R for the 2R profit, or move your stop loss to breakeven in an attempt to let your profit run into potentially 3R or more. If you anticipate a strong trend continuing or perhaps a strong breakout, these can be situations where you may chose this option.
IF you hit 3R open profit, it’s time to make sure you make money on the trade and move your stop loss up to lock on that 2R profit, at that point you would be a fool to not at least make 2R on the trade.
Now, why do I say move to breakeven at 2R instead of locking in 1R profit you might ask? Well, mainly because you need to give the trade room to breathe. If you are committed to letting the trade run for a while, you have to give it room; price will often come back a bit, and probably stop you out at 1R, before moving back in your favour. You will find that if you keep taking 1R profits, over time won’t make you money in the long-run. You’ve got to catch big moves in the market, and that means having the patience and discipline to leave your trades alone and give them the space they need to fluctuate and hopefully surge on in your favour.
5. Don’t get down about a loss
Understand that you will have losses, and there will be times when you see a trade move up to almost 2R and then come all the way back and stop you out for a loss. You cannot get down about this. This approach is about minimizing your thinking and letting the market do the ‘work’ for you. If you get into a game of micro-managing your trades and lamenting over every missed profit, you will be losing sight of the bigger picture, get bogged down in emotion and ultimately end up like most every other trader; a loser.
“But, but, but…”
I can already hear the ‘buts’, the ‘But Nial…’ and I have your answers….
Yes, you will need patience to trade this way, yes you will need discipline. This is about becoming not only profitable trader, but a SKILLED TRADER, and this is how you do it. Through my 15 + years of trading and coaching, I have realized that the big money is made by waiting and taking high-quality trades and not freaking out at a loss and getting out of control. The money is made by catching big moves and making sure your winners more than double your losers.
If you hit a 5R winner one month, that will pay for multiple 1R losers and still give you a profit. What you have to change is you’re thinking; you’ve got to realize that you don’t need to be in the market all the time and that less really is more in trading. When you start getting into a game of day trading or scalping / always being in the market, you are getting closer and closer to gambling and further and further from skilled, patient big-moving catching swing trading (how the ‘big boys’ do it). Remember, the trading industry is designed to get you to trade more, because that makes them more money, but you need to worry about HOW CAN YOU MAKE MONEY, not give it to your broker.
If you don’t have a big account to start with, yes you will be trading smaller position sizes and not making ‘a lot’ of money even on say a 5R winner. But, isn’t making SOME money and being consistent with your approach over the course of a year a lot better than losing money, taking hundreds of trades and being frustrated, confused and mad at year’s end?
You have to let go of the ‘get rich quick’ dream and take a longer-term approach. Focus on trading properly on building your account slowly over time along with a consistent track record. Show me a slow, but consistently profitable track record on a live account, even on only a $1,000 account, over the period of a year, and you will be the type of person with a high potential of attracting funding from private investors or even the attention of prop trading firms or banks.
Most retail traders, both with small and big accounts, doom themselves early-on because they are focused on ‘making money’ fast, rather than on the process of trading and on slowly building their trading account over time. It takes patience and the mindset of a hardened professional to let a trade play out over 2 or 3 weeks and then possibly take a 1R loss. But, I promise you that when you make a 3R winner or even a 2R winner on your next trade, which may take 3 days or 3 weeks, you won’t care about that last 1R winner anymore, you’ll be happy that you got rewarded for having patience and you’ll feel optimistic about your trading future because you’ll know you earned the profit the right way and not through greed or luck.
To get started learning my price action strategies and more about my approach to trade management, check out my professional trading course – here.
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