Update Order Levels as Prices Progress

By Kathleen Brooks, Brian Dolan

Just because you’ve got a well-developed and considered trade plan doesn’t mean it has to be carved in stone. Well, at least the ultimate stop-loss exit should be carved in stone. But when you’re in a position, and the market is moving in your favor, it’s important to be flexible in adjusting take-profit targets and amending stop-loss orders to protect your profits.

The key to being flexible in this regard is also being prudent — don’t adjust your take-profit targets without also adjusting your stop-loss order in the same direction. If you’re long, and you raise your take profit, raise your stop loss too. If you’re short, and you lower your take profit, lower your stop-loss order as well.

Increasing take-profit targets

You’ve put together a well-developed trade strategy ahead of your trade, so now that you’re in the trade, why would you change your take-profit objective?

So what constitutes a very good reason to extend your take-profit objective? Keep an eye out for the following events to consider extending your take-profit targets:

  • Major new information: More likely than not, the new information will have to come out of left field. If it was a scheduled event, like a data report or speech, the market speculation surrounding it would have sopped up all the interest and muted its impact.

    Major means it has to come from the very top echelons of decision-making, like the Fed chairman, the European Central Bank (ECB) president, or other central bank chiefs; the U.S. Treasury secretary; or, increasingly, China. Surprise interest rate changes or policy shifts are always candidates. The more at odds the information is with current market expectations, the better the chances that it will generate an extensive price move.

  • Thinner-than-usual liquidity: Reduced liquidity conditions can provoke more extensive price movements than would otherwise occur, because fewer market participants are involved to absorb the price shocks. Reduced liquidity is most evident during national holidays, seasonal periods (late summer, Christmas/New Year’s), end of month, end of quarter, and certain Fridays.

  • Breaks of major technical levels: Trend lines dating back several months or years, Fibonacci retracement levels of major recent directional moves, and recent extreme highs and lows are likely to trigger larger-than-normal price movements.

  • The currency pair: The more illiquid and volatile the currency pair you’re trading, the greater the chances for an extreme move. GBP and JPY are the most common culprits among the majors, and the commodity currencies (AUD, CAD, NZD, and ZAR) are also candidates.

As you can see, the list is pretty short, and there may be only a dozen or so events in the course of a year that warrant altering your trade plan. Be careful about getting caught up in the day-to-day noise and routinely extending your profit targets — it undermines trading discipline and the basis for your trade strategy.

Tightening stop-loss orders to protect profits

When it comes to protecting profits, you should be much more comfortable about adjusting stop losses to lock in gains. When you’ve got a profit in the market, taking steps to protect it is always a smart move.

When formulating your overall trade plan, always consider what price levels need to be surpassed to justify moving your stop loss. If it happens in the market, you’ll be ready and know exactly what to do.

Focus on hourly and daily trend-line levels, highs/lows, and breaks of Fibonacci retracement levels. When these technical support/resistance points are exceeded, it’s an indication that the market has seen fit to move prices into a new level in the overall direction of the trade.

When that happens, consider moving your stop-loss order to levels just inside the broken technical level. If the market has second thoughts about sustaining the break, your adjusted stop will then take you out of the trade.

For example, say you’re long GBP/USD at 1.5250, your original stop loss is at 1.5180 below, and your take-profit objective is above at 1.5380. Also above is resistance from yesterday’s high at 1.5335. If that level is surpassed, consider raising your stop loss to break even (where you entered, at 1.5250) at the minimum.

To more aggressively protect profits, you may raise the stop further to 1.5315 or 1.5325, locking in 65 to 75 pips minimum, on the basis that 1.5335 should now act as support.

The risk with adjusting stops too aggressively is that the market may come back to test the break level (1.5335, in this example), triggering your adjusted stop loss if it’s too close, and then go on to make fresh gains. But the trade-off in that situation is between something and more of something, or potentially nothing and more of nothing.

Another way to lock in profits in a more dynamic fashion is by using a trailing stop-loss order. After a technical level in the direction of your trade is overcome, similar to the preceding example, you may consider instituting a trailing stop to replace your fixed stop-loss order.

Set the trailing distance to account for the distance between the current market and the other side of the technical break level, possibly allowing for a margin of error in case the break level is retested.