When trading Forex, where you close out your position will determine your profit or loss. This is why you need to determine profitable exit points before you take a trade.
An effective way to manage your risk-reward ratio is to use profit targets. On a chart, you can set a price level where you take your profit. You need to work this out in advance, so you’ll know how much potential reward you can expect from the level of risk you’re taking.
It’s important to measure the difference between your potential profit and maximum potential loss before you enter a trade. The goal is to always trade with a positive risk-to-reward ratio. If your setup shows otherwise, it’s best not to take the trade and look for other opportunities elsewhere.
So how do you identify the most suitable exit points?
Use support and resistance to determine profit levels
While support and resistance levels are often used to identify potential stop-loss, they can be used to determine profit targets as well.
Key resistance areas provide profitable target points when you’re in a long trade. On the other hand, key support areas provide good take profit points when you’re in a short trade.
The idea is to take profit at the point where the price is likely to stop. It’s recommended that you use a buffer in every trade. So make sure that your profit target is a few pips above a support level and below a resistance level if you go short or long, respectively.
Using resistance
Say the prices are moving upward and you want to take a long position.
There are three points you should set to make a profitable exit.
- Enter a long trade before an uptrend
- Look for areas of prior resistance
- Use the previous resistance level to set your profit target
Why should you have this kind of setup? This is because after the market moves up to a level of resistance, there’s a possibility that it will move in a reverse direction. You should take profit before this happens.
Using support
Say the market is moving down and you have a short position. From a short entry, look for a prior area of support. You can then set your profit target at that level.
When the price struggles to break below support, it’s likely to reverse. This is why you should take profit at the support level where the price reaches first.
Because support and resistance don’t always move horizontally, you should also use trend lines, pivot points and channels that represent both.
