By Sean Hyman

To become an efficient Forex trader, you need to have both a good defense and offense strategy so you know when to both enter and exit trades.

As I said in yesterday’s article, your stop-loss is your “defensive strategy.” Your stop-loss is your “plan B,” for each trade – your level when you automatically exit your trade and cut your losses.

But what about your “offensive exit?” How does that help you manage your trades?

An offensive exit really involves knowing when your trade has reached its profit potential. You then set what’s called a limit order at that level, so you can take your profits and reduce the risk to your account balance.

You can do this in a couple of ways. One simple way is to identify points of resistance on a currency chart where your currency pair’s price started to decline in the past. Then you place your limit order just shy of this level.

However, another way is to calculate the difference between your entry and your stop and use that number to place your limit order. The reason for this strategy: You want to make every trade worth your while, with your rewards outweighing the risk involved.  Therefore, you need to set your limit order at the place that gives you the most reward, and least risk on each trade.

Playing Offense: How This Really Works in Trading

Let’s look at an example.

Say I’m bearish on the euro, so I want to enter a trade to short the EUR/USD. I’ve already subtracted my entry price from my stop-level, so I know that I could potentially lose 100 pips on this trade. That means I have a “100 pip risk” on the trade.

If that’s the case, then let’s say I want a 300 pip limit between my entry and limit (take profit) level. That way, I have the potential to get three times the reward of what I’m risking.

Let’s see what this looks like visually on a chart of EUR/USD below. My trade to enter short is entered with a limit entry at 1.2700 (red horizontal line). I’ve placed my stop well above the red, downtrending resistance line at 1.2800 (yellow line), just in case.

If I go for a profit target (sell limit) of 300 pips, then I’d place my limit at 1.2400 (green line). This means that I’m suspecting the EUR/USD price to slip to 1.2400. If it does, then I make three times my money.

It also gives me a 1:3 risk to reward ratio. I’m risking 100 pips by the possibility of my stop being hit. However, I could potentially gain 300 pips if my limit is hit, thus making the risk worth it.

But keep in mind that it takes more than an entry strategy to be successful. In fact, the famous Turtle Traders in the 1980s used to do an exercise with their instructors to calculate risk.

Their instructors forced these traders to place orders by entering the market randomly. The traders then had to manage the trade from where they entered the market rather than starting with the perfect entry point.

Amazingly, these traders were still able to come out profitably because of their risk management skills (percentage risk to their accounts) and because of their focus on their exit strategy. That’s how important knowing where you will exit is!

The exit strategy is a huge key. I saw a Forex trading strategy that managed to earn gains on eight out of 10 trades. But the two times this strategy failed, it wiped away the gains from the previous eight trades! Why did this strategy ultimately fail? A poor exit strategy!

So remember that. It’s not just how many winners you produce or how “perfect” your entry is. If your exit strategy isn’t planned out from the beginning, you’re certainly not going to manage the trade properly. That’s especially the case once your emotions are bobbing up and down as your account balance gyrates all over the place.

Bottom line: The best traders know their exit before they enter. Know this before you place a trade.