Last Friday, I covered my GBP/USD trade. The market had hit my target at 1.61 – with a slight overshoot and was backing off. This was the position then:
I pointed out that the overshoot of the upper tramline is a typical reaction to a development that the market was not expecting. That was the surprise decision last Wednesday by the Fed not to start reducing their bond purchases in September, as the market was expecting.
This has set up the real possibility for a trend reversal, since tramline overshoots, when they come at the end of an extended run, are often a sign of exhaustion of the trend.
Why is this? As the market rallies, it draws in shorts who try to pick the top, convinced that the market is overbought. And as the market climbs higher, many of these shorts are stopped out, adding to the buying pressure.
On a spike move, such as an overshoot, many of the last remaining spec shorts throw in the towel and cover their positions, unable to suffer any more pain.
When they have done their buying, there is a dearth of new buyers to support prices. That’s when the market sinks, as normal selling – some profit-taking by the longs – is enough to drive prices lower. And that is what occurs when the market spikes in an overshoot and then retreats back inside the trading channel.
When to take profits?
Since Friday, where I had a short trade working from Wednesday, the market has been trending lower. This is the current position:
Now, the trade is in profit. The big question is how to handle it.
If I have found the top at 1.6150, ideally I would like to see a small-scale five-wave Elliott pattern down. That is usually a sign that the trend has indeed turned.
Here is a close-up:
I have a very respectable Elliott wave count here – and with my wave 3 containing five sub-waves. I have a positive-momentum divergence at yesterday’s low to confirm my count.
Also, the decline has taken it to the Fibonacci 23% retrace of the big move up from the late August low.
Putting this together, a bounce of some sort is on the cards.
The importance of trade management
If we believe this, then the question arises: do I keep my protective stop at break-even (pink bar), move it down to just above the downtrend line (blue bar), or exit the trade here – or move it somewhere else?
Whatever decision you make is dependent on your trading style. A shoot-from-the-hip style trader would likely grab the profit and run, and get busy seeking out another opportunity.
But a more conservative trader would likely keep stop at break-even and let the market decide its moves, content in the knowledge that the trade will not lose money.
Of course, the market may decide to ignore these bullish signals and resume its downtrend towards my major target at the lower tramline in the 1.58-1.59 area.
Management of your trades is one of the great conundrums of trading – where to take profits – and it pays to have a system. Without a method, you will be left floundering around – and probably be very frustrated at missing some great moves, or seeing a good profit vanish by poor stop placement.