Best profit taking strategies in trading

Though many traders don't know it, a profit-taking strategy is a crucial part of the trading process. Knowing when to exit a trade when in the green is one of the tougher objectives for traders and investors to understand.

This is the exact reason new traders should understand what a profit-taking strategy is and how to implement it into their trading.

Profit-taking strategies are used to determine when a trader should exit and take their profits or cut losses. In order for these methods to be successful, they must be paired with other risk management methods such as position sizing techniques which will help keep you on track throughout your trading journey.

We will jump into exactly what a profit-taking strategy is and how some of the best profit-taking strategies can help you enhance your trading.

What is a take-profit strategy?

A profit-taking strategy is a strategy that describes how you will unwind your open positions and maximise the profits made from them. Traders utilise a variety of profit-taking strategies to reach this outcome.

Some will close their position in one go, while others will look to partially close their position as it moves in their favour. Some traders are likely to set the take profit targets based on technical analysis, while others use a fixed target (for example, in pips or $ value) or might follow their gut feeling (for example, if news comes out that affects their open position).

How do you create an exit strategy?

To find an appropriate exit strategy, you first need to understand your trading strategy as a whole, and what kind of trader you are. Opening and closing trades based on gut feeling is difficult, and most traders (especially beginners) will benefit from having a well-defined strategy and trading plan ready.

The plan should outline how you will determine your entry point, as well as your stop loss and take profit levels. Sticking to them is important, otherwise, you could end up letting your losing positions run wild in the hope that the price will turn in your favour after all while cutting your winning positions short because you feel that you have to bank that profit before the price moves against you.

Refer to our trading exit strategies article to determine which type of exit strategies you could utilise that fits your trading style.

Why is it important to trade with a profit target?

Trading psychology is one of the most difficult parts - if not the most difficult - to master in trading. To achieve consistency, and discipline and improve your risk management skills, it is important to set rules and to have a clear plan of what you want to do and achieve. 

Take-profit levels along with stop-loss levels help you achieve consistency and push you to follow your trading plan. If things don´t work out, it doesn´t mean that you should stop using stop-and-take profit orders, but rather that you need to adjust your trading strategy to set your orders more efficiently.

Best profit-taking strategies to enhance your trading

Now that you understand why profit-taking strategies are so important to implement into your own trading, dive into some of the best profit-taking strategies below.

1. Trend following exits

The most basic of all trading strategies revolve around moving averages. Since indicators were created, the moving average is one of the most frequently used methods for getting in and out of the market.

Using moving averages for your exits has the advantage of simplicity. And, if you like exits that don’t require a lot of your time, the moving average exit ranks up there as one of the best.

Moving average exits are best used in trending markets.

5 and 20 periods simple moving average crossover exit.

As you can see in the chart above, US500 was trending powerfully during the bull run of H1 2021.

The 5 and 20-period moving average exit is as simple as it gets. You wait for the 5-period (blue line) to cross below the 20-period (maroon line) to signal your exit.

As you can see from the chart above, it would have provided a decent run on the US500, allowing you an excellent opportunity for profit.

The chart above shows a consolidation period on AUD/USD when this style of exit gets ‘choppy’. This means you are getting exit signals more frequently as there is no trend in place.

And, if you are using the same signal to enter the trade, then you would be getting chopped in and out, resulting in a series of small losses and break-even trades.

2. ATR trailing stops

ATR stands for Average True Range. The ATR exit takes into account the volatility of the instrument you are trading at the time.

When FX pairs are volatile, it makes sense that you need to give your exit more room to move.

Conversely, when FX pairs are less volatile, a closer stop will work better, allowing you to give back less open profits.

A trend following ATR stop would set the exit at 2-3 times the daily ATR from the low of the day. So, if one ATR was 30 pips, a 2ATR stop loss would trail behind the loss of the day by 60 pips (2x 30 pips).
A short-term ATR stop would set the exit at around 1.5xATR from the low of the day.

As you can see in the chart of gold above, the ATR from April 2021 to mid-August 2021 has ranged from 17.70 to 31.37.

This means at its peak volatility (during this time period), gold was moving around $31 per day. 

The main benefit of this exit is you use the ATR to dictate your exit, so you reduce your chances of getting a premature exit.

If you set your exit at say $10, then during times of high volatility, your chances of getting whipsawed out of your trade will increase dramatically.

The beauty of this exit is that the ATR is calculated automatically for you every day, and you can use that information to adjust your exits accordingly.

3. Using support and resistance for exits

Another exit you can use is to set a profit target based on support and resistance lines.

If you notice an FX pair, index or commodity that is range bound, you might like to take advantage of the movement by buying weakness at the bottom of the range and selling strength at the top of the range.

The chart above highlights a range-bound period in NZD/CAD in which the currency pair consolidated within a 300 pips range. If you were buying weakness on support, then you could set a profit-taking exit ahead of the key 0.89 resistance level.

Let’s say you were getting entry signals ahead of the 0.86 support level, you may set your take profit level just before 0.89.

4. Using divergence signals to exit your positions 

Divergence is one of the strongest signals you can get when trading any instrument. You have both bullish and bearish divergence.

Bullish divergence is when the price is hitting a lower low but your technical indicator, preferably an oscillator like the stochastic or RSI, is making a higher low.

Let’s assume you were long USD/CHF from the December 2020 low.

But by mid-March, you notice a bearish RSI divergence on the daily chart.

In this case, you could exit the trade based on the bearish divergence before the correction picks up momentum.

5. Time-based exits

Good trades usually start to work in your favour quickly. Conversely, some trades will hover and do nothing for extended periods.

For an intraday trader, your time-based exit could be as little as 10 minutes, whereas an end-of-day trader could allow five days of sideways movement before exiting. You need to work your time-based exit based on your trading timeframe.

The silver hourly chart above shows a consolidation period, which would have been painful to sit through for a short-term trader.

6. Candlestick exits

There are a handful of candlestick exits you can add to your trading strategies, and most have interesting names.

Who wants to stay in a trade after a ‘dark cloud cover’ or ‘bearish engulfing pattern’? Just the name alone should be enough to send you a warning signal that something is not quite right.

Your goal here is to get familiar with the full spectrum of candlestick patterns and test them to see which ones work for your trading system and time frame.

The chart above shows a bearish engulfing pattern, which is where the previous green candle is engulfed by a much bigger red candle. The longer the 2nd candle (down day), the greater the likelihood is for a more significant sell-off.

7. Fundamental exits

When a major news item hits the financial markets that is a shock to the economy, you may be best off exiting your position.

There are plenty of fundamental news events which can be significant. But none are bigger than a US Presidential result, especially when no one is expecting it. On November 8th 2016, Trump became the President-elect.

As you can see, the Dow Jones rallied 9100 points in just over a year following this major fundamental news. If you were bearish on the news, it would have been very smart (in hindsight) to exit your position immediately.

Other fundamental news events you may like to think about when trading the markets include:

• NFP results & all unemployment data
• Central Bank rate decisions
• GDP figures
• Inflation data (CPI)
• FOMC & ECB meetings

What is the best profit-taking strategy?

There is no single profit-taking strategy that is better than the rest. It comes down to your trading plan and strategy. We have listed some of the most used profit-taking exits above and suggest trialling what ones work best for you.

Ready to trade your edge?

Join thousands of traders and trade CFDs on forex, shares, indices, commodities, and cryptocurrencies!

This information is not to be construed as a recommendation; or an offer to buy or sell; or the solicitation of an offer to buy or sell any security, financial product, or instrument; or to participate in any trading strategy. It has been prepared without taking your objectives, financial situation, or needs into account. Any references to past performance and forecasts are not reliable indicators of future results. Axi makes no representation and assumes no liability regarding the accuracy and completeness of the content in this publication. Readers should seek their own advice.