When to Enter or Exit a Forex Trade – Step by Step Guide
Forex trading is associated with buying or selling a currency pair in order to profit from the difference between the entry and exit price. If the difference is positive, a profit is made, while if the difference is negative, the trading account takes a loss. Entering and exiting a trade is a tricky thing, as sometimes other factors influence the outcome of a trade, and as a result the profitability is not always subject to a technical or fundamental analysis. For example, depending on the type of trading account, the broker may be obligated to fill your orders if there is a market. Excellent? Maybe, but what if there’s no market where your order is being placed? The best example comes with the latest 2015 Swiss National Bank (SNB) action when it dropped the peg on the EUR/CHF cross. Many traders were long with a stop loss below 1.20, where the peg had been set for so many years. When the SNB dropped the peg, there was no market to be found all the way to below 0.88, and the broker could not execute the stop loss orders. As a result, the orders were executed at much lower levels, and traders had to come up with the difference to cover the loss.
Entering/Exiting a Trade
There are two ways to enter/exit a trade: at market, or using pending orders. Trading at market means that the trader will simply use the currency quotation listed by the broker in order to enter a trade, and the exit can happen in exactly the same way, at market, at a future date in time. While entering a trade at market is perfectly fine, it is strongly recommended that for exiting a trade, take profit and stop loss orders should be used. One may ask what the point is of using a stop loss order if the broker is not able to fill it, like in the SNB example above? The correct answer is that the SNB event was one of a kind, an unprecedented event in the brokerage industry, and the vast majority of brokers took the clients’ losses on their own balance sheet. This came as a common response to show that the brokerage houses do care about uncommon things, and put clients’ interests first. Despite the common belief, a broker is not after the client’s money, as it gains from the transactions a client makes. In view of this, their interest lies in having more active clients rather than screwing with their open positions. If stop loss and take profit are mandatory when exiting a trade, entering a trade can be done in multiple ways.
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Pending Buy Stop Orders
Using pending orders is subject to an analysis that is already completed. This means that the trader has an idea about future levels he/she wants to sell or buy at, either from a technical or a fundamental point of view. If the future level is the result of technical analysis, then the trader will want to buy or sell at support or resistance level. If, on the other hand, it is the result of fundamental analysis, then the trader will want to buy or sell based on the outcome of an economic release: i.e., whether or not it matches market expectations. When a trader wants to buy from higher levels, he/she can do that by placing a pending buy stop order. Such an order is necessary, as Forex markets can move unexpectedly, and one cannot stay in front of the screens 24/5. At the moment the order is placed, the future take profit and stop loss can be set as well, and they will be automatically filled by the broker by the time the pending buy stop order becomes active.
Pending Buy Limit Orders
Pending buy limit orders are similar to pending buy stop orders, the only difference being that the buying is intended to be done at lower levels when compared with the current ones. Therefore, either buying is done at a future support level, or the trader has an analysis from longer timeframes, and wants to buy in a specific area that is currently below market prices.
Pending Sell Stop Orders
A pending sell stop order is placed when there is a belief that the market will collapse and break through an important support. For example, if the market is consolidating in a contracting triangle, or another pattern that calls for lower levels by the time it is completed, then placing a pending sell stop order at the lower part of the pattern is the thing to do. This way, the trader profits from the pattern being broken as the bigger trend resumes falling.
Pending Sell Limit Orders
A pending sell limit order is placed when selling is intended to take place at a higher level. Usually, this kind of trading is associated with a trader’s intention to pick a top in a bullish trend, or to fade a move caused by an economic event or release. While trying to pick a top or a bottom is a risky approach, they are really rewarding, providing the stop loss is not hit.
Other Factors That Influence Execution
In recent years the brokerage industry has changed very much, as online retail trading is available anywhere. With a simple Internet connection, anyone can access financial markets either from a desktop or a smartphone. Technology at the broker’s end has changed as well, and now the broker can offer a market execution for pending orders. This is good and honest, but it can be misleading depending on the trading style one has. For example, let’s assume the Non-Farm Payrolls in the United States is due to be released, and the EUR/USD pair is trading in a small range between 1.1230 and 1.1250. I am bullish and want to buy a break higher, and therefore place a pending buy stop order at 1.1260. However, I am a scalper, and go for only 10 pips take profit, so I set my take profit at 1.1270. So far so good. The problem with market execution is that the market will move so fast that the broker will probably fill the pending buy stop order at 1.1263 or higher, and exit at 1.1270. This is called slippage, and because of it I just made only 7 pips profit instead of 10, not to mention any commissions or spreads as additional costs. All in all, using pending orders is recommended, as the assumption is that there is a trading plan in place. This means that trading is not arbitrary, and chances of survival in the long run increase.
Other educational materials
- How Do I Make a Profit from Forex Trading?
- Forex Market Terminology
- Profit from Forex Trading Using Different Trading Styles
- How to Set Up an Expert Advisor
- HFT (High-Frequency Trading) in Forex Markets
- Trading Sessions and Their Importance
Recommended further readings
- Mathematical Foundations of Realtime Equity Trading. Malyshkin, V. G., & Bakhramov, R. (2015). Liquidity Deficit and Market Dynamics. Automated Trading Machines. Liquidity Deficit and Market Dynamics. Automated Trading Machines.(September 13, 2015).
- “Exchange rate effects on the volume and variability of trade flows.” Barkoulas, John T., Christopher F. Baum, and Mustafa Caglayan. Journal of International Money and Finance 21, no. 4 (2002): 481-496.