Where should you take profits?

published 19 January 2011

In my last post, I described a recent trade in the EUR/USD which provided a nice profit in a two-day trade.

But I could have made a lot more by not being so quick to take profits when I did.

This is a constant dilemma for swing traders: where to take profits. I will say right now that there is no easy answer. Let's have a look at the chart as it developed after my exit.

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I'd gone long at $1.2950. I then took my profits at $1.3128 (see here for details of the full trade), basing my exit on an expected reversal at the Fibonacci level around $1.3150. However, the market had other ideas (they often do!). The euro carried on relentlessly upwards to challenge the previous $1.3430 high and then spiked above to make a new high, at least temporarily.

That was annoying. I could have taken an extra 200-300 pips out of this trade in a matter of a few hours. That added up to £400-£600 left on the table for my £2 bet.

I take comfort in knowing that these extreme situations do not come along very often. I made the percentage play, as most of the time in these retracement rallies of a bear market, the rallies stop at or near a Fibonacci level based on the previous wave. So now, I can throw out my Fibonacci analysis of this particular wave, as it is invalid because the 'retracement' has taken the market to a point above the pivot high of $1.3424.

(click on the chart for a larger version)

An alternative protect-profit method

Instead of exiting a profitable trade with resting orders set at a Fibonacci level, I could have used a 'trailing stop' method and raised stops hourly, based on the movements on the hourly chart.

Personally, I don't like this method, as most of the time, a normal zig-zag would stop me out prematurely. So I'm afraid it's horses for courses in this matter. The main point is that it is important to have a plan in mind on how you will exit a trade when it is 'live' it's all part of the trading discipline and money management that will keep you from losing too badly on any one trade.

What is a pip?

Several readers have asked me this question it's simply trader slang for 'point', or the minimum tradable increment in price. Taking gold as an example, the minimum move in gold is $0.1/oz (ten cents). When betting £1 per point (pip), this move is equivalent to £1 in your account. A move of ten pips is a $1 move, or £10 in your account.

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John is is a British-born lapsed PhD physicist, who previously worked for Nasa on the Mars exploration team. He is a former commodity trading advisor with the US Commodities Futures Trading Commission, and worked in a boutique futures house in California in the 1980s.

He was a partner in one of the first futures newsletter advisory services, based in Washington DC, specialising in pork bellies and currencies. John is primarily a chart-reading trader, having cut his trading teeth in the days before PCs.

As well as his work in the financial world, he has launched, run and sold several 'real' businesses producing 'real' products.