Over the last few articles I have written for the Lessons from the Pros, I have gone right back to basics and explored the most fundamental aspects of consistently profitable trading, like having an easy to understand plan, using strict capital preservation skills and knowing when to and when not to take a trade. Over these articles, we have explored the theory behind these simple rules, so I thought what better than to follow-up these lessons with a real-life practical example from an actual trading opportunity I recently showed my students during the ongoing Extended Learning Track (XLT) - Futures and Forex online programs.
As I have stated before, I like to mix my trading styles up between both intraday and swing trades. Out of the two, I would always say that my preference is for swing trades as I like to be able to analyze my charts, find my trading opportunities, set my stops and targets and go away and do something else. Of course, I don't mind spending a few hours a day at the screen taking day trades, but the beauty of the set and forget style is that it allows me to maximize my time to do other things. I always encourage newer students of the Forex markets to adopt this approach to the their trading in the first instance, as it also encourages them to plan their trades well in advance and remove many of the elements of emotional decision making often found in day trading. All that is required for a solid low risk, high potential reward swing trade opportunity is for the objective trader to find their entry point (in my case, a quality supply or demand level), set a stop loss order to protect their money if they are wrong and the final and often most vital part of the trade, the profit target. Without a profit target for exit, what would be the point of the trade in the first place? Are we here to just place trades, or to actually attempt to make money after all? With this in mind, I would like to focus on the importance of profit taking during any trade setup.
First, let's look at the trade setup I showed the students in the XLT. It involved recognizing a quality supply level on the EURUSD futures contract, where I was looking to enter a short position:
In the example above, we notice that on this 60 minute chart of the EC Futures, price was rallying to an area where the market had objectively shown us that supply was greater than demand, in the 1.4500 to 1.4540 price range. The order was planned and placed to short in this region, two whole days before the market actually reached the area. In conjunction with the entry, it was also important to mark off an objective profit target and exit for the trade as well. It is amazing how many novice traders fail to focus on their exits for trades, mainly placing most of their attention on where they can get in! Just as the entry was defined at supply, we can also indentify the lower area of demand between 1.4270 and 1.4300 as the objective profit target, as shown in the chart below:
After the trade has been planned and the orders for entry, stop and target have been put into the system, we can let the market do the rest. For the consistent trader, the hard work (the analysis) has been done, but for the novice emotional trader, it may be about to begin if the trade gets filled. Once live in the market with an open position, it can be increasingly tempting to watch the market move tick by tick. By doing this, a trader can also be easily swayed by greed if the trade starts to work out, thus moving the targets further out. It is vital to remain objective at all times and stick to the pre-defined plan throughout the trade no matter what happens, as shown in the chart below:
With an objective and unemotional profit taken in the lower demand zone, the trade provided a healthy risk-to-reward ratio, but if we had gotten greedy in the position and hoped for more, we would have seen price reverse sharply and given back a substantial chunk of the trading profits. By being truly objective in my exit, I secured a good profit from this trade in around 24 hours as shown in the following statement:
Of course, the trade could have run more, but it also could have stopped out or broken even. In this case, it hit my target, signaling my exit and allowing me to walk away with a great reward for very little risk which is my primary aim in trading.
A useful trick to prevent giving back profits during a successful trade (something we have all been guilty of) is to ask yourself where you would enter a new trade if you were not in a trade right now. This should help to prevent that sickly result of finding oneself doing well on a trade one minute, only to give it all back the next. This is an outcome I have witnessed in many new traders over the years. Of course, we should remember that we need to take trades to profit, but we also need to take profits to make money. Always remember to plan your entry, your stop and your exit together for maximum consistency in your trading.
This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever. Trading and Investing involves high levels of risk. The author expresses personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The author may or may not have positions in Financial Instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein. Past performance does not guarantee future results.