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Letting your profits run might be a flawed forex trading strategy

Jan 12 • Forex Trading Articles • 936 Views • Comments Off on Letting your profits run might be a flawed forex trading strategy

Forex trading can feel haphazard and chaotic at times. You can quickly eliminate these potential negative influences by exercising both self-control and trading control wherever and whenever you can. You can achieve this objective by applying a basic system of rules to your decisions.

As individuals, we crave security, certainty, routine and control in many areas of our life, and trading is no different. Controlling your risk gives you maximum control over your FX trading outcomes. If you only risk 0.5% of your account size per trade and limit yourself to five FX transactions per day, you immediately put yourself in control by limiting your total potential losses to 2.5% account size per day.

If you hit this limit by losing five trades in series, then you’ve experienced an unfortunate series of events. It’s unlikely in terms of probability to have five losses one after the other, and such an unlikely event should prompt you to reassess your method and strategy because it could be deeply flawed.

Other control methods could include only trading the major forex currency pairs. You’ll consistently get tighter spreads, experience less slippage and your fills will be more precise. For example, compare the overall costs and risk of trading EUR/USD to EUR/TRY.

Take care of the bottom line, and the top line takes care of itself

There’s a reason why trading mentors continually encourage novice traders to protect their bottom line; it allows traders to remain trading for as long as possible with their first account while they learn their trade.

If you lose perhaps 25% of a small trading account as you perfect your craft over a few months, then you could consider the loss as a sink-cost or the cost of your education. Critically your account isn’t wiped out and neither are you, you’re still in the game and shouldn’t experience any trader-psyche damage.

You can control your exposure and risk by using stop-losses, which offer you a sense of security. You can confidently trade knowing that you have limited your loss on an individual trade and put in place a circuit-breaker to prevent catastrophic failure.

But what about limiting your gains, why would we engage in this counter-intuitive exercise?

Our trading world is full of trading cliches; “letting your profits run” is one of the most popular and misunderstood. The suggestion is that you allow your winning trade to reach its maximum profitability, before closing it. While it reads as sound theory, letting your profits run collapses when practised.

As mentioned previously, probability has a significant impact on our results and our decision making. We can’t predict a security’s price. We can’t be 100% sure of where the price will peak or trough. We can use various technical indicators (TAs) to pinpoint where momentum has become exhausted, but these are lagging not leading indicators.

A momentum oscillator such as the MACD will signal it’s time to change when the price has already peaked, but TA is never an exact science. Indicators can only pinpoint the absolute peak of price in hindsight.

We mentioned probability earlier and touched on the impact the phenomenon has on all aspects of your trading outcomes. You can apply probabilities regarding how far price will rise or fall on any trading day.

Using pivot points to decide where to place your take profit limits

You know the theory behind pivot points. The daily pivot point (PP) uses the previous day’s results to draw a line on our chart. The PP of an FX pair gets calculated by combining the high, low and close of the day before. The PP gives you an excellent pivot to base your trading decisions for the day’s sessions.

You can plot your PP and the three levels of support and resistance on your charting package that comes with your MT4 platform. If it’s not part of your forex broker’s standard indicator package, a quick search will take you to forums where you can obtain the code for free.

In studies of the major forex currency pair movements, market analysts concluded that price only reaches the extremes of R3 or S3 during 3% of trading sessions. Straight away we’re given clues as to where we should and shouldn’t place our take profit limit orders, and in a correlated lesson where we could consider placing our stop losses.

We don’t have to guess where the peak of price movement might be during any session; we can use that 3% probability rate to guide us. If we know that there’s only a 3% probability of price reaching R3 on a long FX trade, we could consider never placing our limit order close or above this level. Similarly, with a short trade S3 becomes regarded as out of bounds. We don’t let our profits run; we make an educated decision based on history and probability where the extremes are and where the price of a security is unlikely to reach 97% of the time. We then use our take profit limit order to capture the statistically most likely pip gain.

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