Strong one-way markets in currencies can go on for much longer than people might think.
If your reaction to an over-bought or over-sold market is to take profits, you might be committing a cardinal trading sin – cutting your profits short. Instead of rashly closing out of your gains, you can follow these steps instead.
Know what tends to happen next
After a strong market move, unless it becomes very volatile, you will tend to get a consolidation phase. It will typically come either before the market bottoms and reverses, or before it continues on its merry way.
Play the probabilities and wait for the consolidation, but be prepared with a plan in case the reversal is sharp.
Notice the reaction to the news
For the trend to continue, you generally need to see the market reacting “correctly” to news. If the news is bad, but there is no follow-through in the price, then it could be a sign that the trend is slowing down. If the news is good, and the market keeps going in your direction (or the bounce is weak) then the trend could have a lot of legs left. If the news is good and the reaction is bad, then something is happening that you don’t understand, and you will need to re-evaluate your position.
Don’t try to be 100% right
There is nothing wrong with taking some profits, locking in others with a tight trailing stop, and keeping a chunk on the table with a stop well out of the way. If you make your exit an all or nothing decision, it can be hard to get it right. You will just end up feeling like you have missed out if the market continues to trend. This is a recipe for you to make mistakes.
Think about who could reverse the direction of the trade and why
Think about what buying or selling could be happening at the current level, and what has the potential to drive the price higher. For example has something changed in the markets, which is going to cause an increase in merger and acquisition activity? Will the demand for the country’s bonds be increasing or decreasing?
Sometimes to get really big wins you need to suffer large drawdowns in your profits
The markets don’t go in a straight line. On the way to a distant target, there can be significant pullbacks. Sometimes you just need to channel your inner Ed Seykota and hold on though the swings. Keep your objective for the trade in mind, and don’t be swayed by minor pullbacks and blips.
But don’t just hold on and hope
Don’t use any of the reasons I have given above as an excuse to hold on and hope that the trend is going to continue, when really it’s done and dusted. Be in the moment with the market, and notice when things actually have changed.
About the Author
Sam Eder is a currency trader and author of the Definitive Guide to Developing a Winning Forex Trading System and the Advanced Forex Course for Smart Traders. He is a part owner of Forex Signal Provider fxrenew.com (You can get a free trial). If you like Sam’s writing you can subscribe to his newsletter for free.