In the forex faq this week, we shall be discussing on how to detect false reversal signals as well as when is the right time to exit a trade.
Below is the question from one of our fellow readers:
Usually I enter a trade at right time. But my problem is that I close it prematurely . I need some patience. But how to detect the false reversal signals?
Since you are able to enter your trade at the right time, that means that you have a great entry strategy on hand. I do not know what you mean by prematurely as you did not specify more about it.
I assume that you are exiting your position based on the reversal signals that you get from your chart. However the price actually continue to move in your direction and I bet this is the premature situation that you are talking about.
First of all, I must tell you that there is no way you can 100% identify a reversal correctly. What you can do is to gauge it according to the probability of a reversal.
However my personal advice to you is not to exit your trade using a reversal signal. What I do for all my strategies are I exit them based on risk reward ratio that are tested over a period of time.
If you are a student of mine, you will know that I exit my position at a certain profit. How I actually figure out this particular target profit to exit my trade for each stratey is by doing a backtesting on the strategy for a start.
For example, you have a strategy on hand at the moment. What I suggest you to do is to move your chart back to 3 to 6 months before and then check your chart to see if you have any trading opportunity.
Then you will record down the maximum drawdown for each trade as well as the maximum profit move for each trade. Do it for entire 3 to 6 months and then you will have a good amount of data to use.
From your data, you can then see that the price usually get stopped out at which level and then you will be able to set your stop loss effectively. For example, 75% of your data show that the price moves down 25 pips most of the time and then move back up, then you will set your stop loss for that strategy to be at 30 pips. This means that you will not be stopped out for 75% of the time.
Next you will take a look at the maximum profit for each trade. Let says that the trade usually hit 70 pips and therefore you will set your target profit to be slightly lesser so that you can confirmed a hit. That will be around 65 pips.
With a 30 pips stop loss and 65 pips target profit strategy, you actually have a strategy that has a risk reward ratio of 1:2.16. With such a strategy that wins 75% of the time and has a risk reward ratio of 1:2.16, you will be making money from trading every single month without fail.
The above are how I formulate my own strategies that are taught in my forex mastery course as well as break the bands strategy course. Try it out on your own strategy and you will be able to have an accurate point to exit your trade.
I hope that I have answered your question and I believe that this post will be very useful for every trader here in this blog. Do feel free to give your comment below as it will be very useful for other traders here in this community.