Forex Strategies and Tips
Exit Strategy: Fixed Take Profit
As we discuss in our article About Exits, there are 2 basic kind of exit plans: Active or Passive. This is the passive approach, because you plan your take profit at the time you place your trade. You set it and you forget it.
There are several reasons why this is a great approach to trading. You will often hear forex teachers saying "Let your profits run and keep your losses small", and that's always great... when it works.
But how do you know which trades are going to run, and which are going to putter around and then reverse?
Leaving Money On The Table
This is the crux of the problem.
The problem is not the part of leaving behind money you might have taken; the problem is the fear of leaving money behind.
In Forex trading, you will always leave some portion of available profit behind. It's inevitable. It's part of the process and if you want to be successful you have to learn to be ok with that.
Mark Douglas, the author of the must-read book for all forex traders, Trading In The Zone defines it as one of the primary trading fears...
When we leave money on the table, we can't blame the market…in other words, there's no way to rationalize the pain away.
Believe it or not, of all the skills one needs to learn to be a consistently successful trader, learning to take profits is probably the most difficult to master.
A multitude of personal, often very complicated psychological factors, as well as the effectiveness of one's market analysis, enter into the equation.
I point this out so that those of you who might be inclined to beat yourselves up for leaving money on the table can relax and give yourselves a break.
Eliminate Fear With a Fixed TP
After many years of trading, using a fixed take profit has become one of our most reliable exit plans.
Here are our top 7 reasons:
1. It takes the emotion out of our trading. The trade either works or it doesn't.
2. We're more at ease because we no longer sit nervously in front of the computers with our finger on the trigger ready to pull the trade. By this point we understand that we don't have a magic crystal ball to know what price is going to do.
In the past we became so frustrated by pulling a trade that was stalling only to find that it would have hit our profit target had we left it alone. There's no way to know if the trade is just doing a retracement and will continue to trend in our direction or if that's all it's going to do and this is the place to pull it before it backs up on us and takes away all of our pips.
3. A fixed take profit limits our exposure in the market. The longer you hold a trade, the more things can happen along the way.
4. It reduces our onscreen time. We set our trade because we trust our strategy, our analysis and our entry and we leave it to work or not work. We don't micromanage it and obsess over it after we place it.
5. We've also seen that sometimes an early exit with a fixed take profit yields a second entry off of the retrace for an additional fixed profit yield.
6. We've done extensive testing and have logged all our trades in the Trade Log and have done careful analysis of various exit strategies, including volatility stops, trailing stops, support and resistance stops, fractal stops and many more.
There are always some trades that can show brilliant results with one method over another but when we ran these tests over years of data with our own strategies, none of them proved any better than the simple fixed take profit. So at this point we have definitive proof for our own strategy of what works for us and what doesn't. (Read this article to see how to analyze your own trades).
7. And best of all, we've recorded our own sound file that says "Ka Ching" every time we hit our profit target. And that's the sweetest sound! "Ka Ching".
How Much Profit to Take
There are 3 ways to go about determing how much profit you aim for as your fixed Take Profit:
① A static fixed number, e.g. 20 pips, regardless of which currency pair you trade or session.
② A percentage of the ADR or ATR of each currency pair. The ADR is the Average Daily Range; ATR is the Average True Range. Taking 10 pips on the quiet USDJPY is not like taking 10 pips on the wild GBPJPY, so you look at each pair separately and use a static goal that varies with each pair.
③ A ratio of the stop loss you used. For example, you could aim for a Risk-to-Reward (R:R) ratio of 1:2. If you put on a trade with a stop of 20 pips you would set a take profit of 40 pips.
Which is the best approach?
In our article about exits About Exits we describe how to set up the Trade Log to compare exit strategies. The same technique can be applied to comparing your take profit goals.
Do your best to estimate what your actual results would have been for each trade you take if you had used method 1, 2 or 3.
For each strategy we evaluate we also put time into looking at what the best ratio might be. For many of our strategies the sweet spot of overall best profit came when we used less than 1:2 risk to reward. We often found that 1 : 1.6 (ex: 20 pips stop loss to 32 pips take profit) or 1 : 1.8 gave us more net profit... not on each trade but on the entire set of trades we took over several months.
You might not find that to be the case, but see for yourself.
And remember - don't just look at a few trades. The more trades you look at and the more data you gather about each one, the more useful it will be to you.