How to Use Indicators to Implement Low Risk/High Reward Trade Ideas – Part 2
In the first part of this article, we looked at how you can use indicators to trade with the trend and identify low-risk entry points.
In part 2 we delve into perhaps a more important way to use indicators – for your exits.
By having a variety of exits that allow you to effectively manage risk and adapt to changes after your entry, you give yourself the tools you need to become consistent.
A good exit strategy will allow you to let your profits run, cut your losses short, and take profits at logical places.
Find the right balance
Don’t make your exits an all or nothing decision.
Instead scale-out part of your position at a time. This will allow you to strike the right balance between taking profits when the market makes them available, and leaving some on the table for big wins.
How many times to scale-out?
I prefer to scale-out of each position three times. This provides enough options to handle different situations while at the same time keeping it simple enough to avoid confusion.
Indicators across timeframes
Indicators are useful for both short and long-term trading. The techniques noted here can be applied on everything from a five minute to a monthly chart.
The trick is to think about what you are trying to achieve with that indicator.
You can then adjust it to do the job you need it to do, based on the characteristics of the timeframe and time of day you are looking to place your trades.
Just note that the lower the timeframe you go, the more rapidly the market type will change and there will be more “volatile” market types. This means careful planning is required, as a set of indicators only tends to work well in one or two market types at a time.
Taking some off quickly
Taking off some of your position quickly does two things:
- Improves the consistency of your trading strategy by increasing the win rate
- Make the trading strategy easier to trade as you have more winners
Stochastic indicators can be used for this purpose. When the stochastic becomes overbought (if you are buying) or oversold (if you are selling) then you can look to take profit.
Bollinger Bands also work well for this.
When the price hits the upper Bollinger Band (if you are long) or the lower Bollinger Band (if you are short) then you can take profit.
Some strategy: Combine these indicators with support or resistance levels to exit at turning points.
Capture the big wins
To maximise the risk vs. reward on your trades, you need to let your profits run as much as possible.
This can be difficult to do without an objective method, which makes indicators particularly useful for the job.
For example you could trail your stop-loss on the Kijun-sen (part of the Ichimoku Kinko Hyo).
The MACD offers several ways to capture a trend. You can exit when the histogram crosses the mid-line. This approach will let you capture long-term trends, but at the same time it will mean you have to give back a lot of your profits if the market reverses rapidly.
You can see it works well on the daily chart of the EURAUD to capture the middle chunk of the trend.
If you want to let your profits run but not suffer through deep pull-backs, you can look for the histogram to cross over the signal period.
Here is the daily chart of the GBPUSD.
Don’t forget you can adjust the settings on the indicator to trail the stop tighter or looser, depending on what you want to achieve.
Another great tool for this job is the Parabolic SAR.
This indicator is designed to trail the price (and progressively lock-in profits) as the trend continues in your favour.
Some strategy: Wait until a trend has broken out before using this type of indicator. It won’t work well if the currency pair is trading in a range.
Keeping Windfall Profits
Sometimes the currency markets really go for you.
It might be because of a news event, or it might happen at the end of a trend where everyone looks to jump on board.
In these circumstances your typical trailing stop is not going to do you justice. What you need is an indictor that trails the price closely.
In this case we use the 3 period moving average displaced by 1 period. Look for the price either to touch or close back over the moving average, and use this as an exit point.
You can also use the Tenkan-sen (part of the Ichimoku Kinko Hyo) which will trail the price closely during a fast moving market.
Some Strategy: Combine with candlestick reversal patterns to capture more of the move.
Over to you...
Indicators can be a great way to implement your trades in a manner that reduces risk and increases reward.
Now you know the basics, it’s up to you to start testing your ideas and getting them down in a written trading plan.
Keep it simple to start with, by choosing your top two or three indicators and applying them to the chart timeframe you trade. Once the indicator is on the chart, scroll back in time to check to see if it does what you thought it would.
When you are ready, begin to trade the indicators live. Be sure to follow your written rules and keep a trading journal. That way you can make controlled changes to your indicators, or add new ones into your plan based on the results of a series of trades.
It’s through this process that your indicators will get you to where you want to be with your trading.
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