Other Kinds of Forex Stops – Signal, Time, Targets, Execution
This lesson will cover the following
- What other kinds of stops are there
- How risk increases over time
- Learn about target and execution strategies
In previous articles, we discussed a number of stop strategies based on price action. However, other exit strategies can also be implemented. These are based either on a particular technical signal or on time.
Signal Stop
It is an obvious stop indicator. A signal stop usually occurs when the system provides a signal to enter a position in the opposite direction to the existing one. It is part of the so-called stop-and-reverse system.
Time stop
As time and the reward-to-risk ratio are multidimensional in essence, a time stop can be used in short-term trading when time, the cost of money and opportunity cost are relevant. This stop is usually intended to enable a trader to exit his or her position at a certain time after the entry has been made. If no profit is achieved within that time window, the probability of it occurring later decreases. Therefore, the position needs to be closed if the trader is to avoid additional risk. A widely used variation of this strategy is to reduce the size of the position after a certain period has passed. This approach is meant to reduce risk while still giving the position room to generate some profit.
Targets
Exiting at a target price can serve as an exit strategy. In the case of short-term trading, monetary targets are commonly used. ‘If I gain $250 on this trade, I’ll exit’ is a common scenario. Traders may test their targets, provided the target-calculation method is easily quantified. For longer-term targets, the size of the position can be reduced or trailing stops can be tightened with the help of money stops or volatility adjustment. Combining a target with a time stop allows target prices to be adjusted as time passes. This reduces the likelihood of risk increasing as time affects profits. Target levels should be set alongside a trailing stop to avoid giving back profits already earned if the target is not reached.
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Support and resistance are powerful concepts used by traders to interpret price action and set targets. They are based on the theory that the price may struggle to break above a certain resistance level or below a certain support level. A trader can use this to determine profit levels. If one has entered a long trade, key resistance areas can be a good place to set profit-target levels. If one has entered a short trade, key support areas can be a good place to set ‘take-profit’ levels.
Another effective way of working out take-profit levels is to use daily-range levels. To identify these, a trader may use the average true range indicator (ATR). It shows exactly how far one can expect a price to move on any given day, based on recent price movements.
Execution
Execution-risk strategies are particularly useful in short-term trading, where profit margins are often determined by executed prices and slippage. Entry execution is based on the timing at which the system provides a signal. Exit execution may allow for some experimentation. A trader should exit near the close of the day in order to avoid overnight risk. The opening of a trade is usually a more emotional moment, which can be either an advantage or a disadvantage.
Another way to execute an entry or an exit is scaling. This is practised more by institutions that hold large positions, but it can be equally useful for a smaller trader, provided he or she can afford to operate with more than one standard lot. Scaling generally means entering or exiting a position over time in small amounts. More about scaling can be found in our next article.