In this chapter I will show you what the best methods of exiting positions are. With the Fibonacci extension tool, it is quite easy to get ahead of other investors.
Way no. 1
The tool we will be using to define the exit point is the Fibonacci extension. There are some rules which traders follow, basing on how deep the correction was. Have a look at the table below and then move on to examples.
Correction to: Look for the exit at the extension of:
Let’s assume that we have found an uptrend. We wait for a correction to enter a long position. Correction is shallow, only the 38.2% retracement line. We go long and now there is a question –when to close this trade? Many traders follow the rule that the move up from the 38.2% retracement may end at the 138.2% extension line (exactly as in the table presented).
It is not something written in the stone. They are simply aware of the statistics and probability. They know that there is a big chance that the move will end or stop for a while there.
Move to 138.2% extension line.
When the correction is deeper, there is a greater chance that the continuation of the main move will be stronger. As you can see in the table, a correction to a 50%, 61.8% or 78% retracement may lead to a stronger move up to the 161.8% extension level.
In next example, there is an hourly chart of index presented. From a higher time frame we know that the main trend is down. There is a correction ending at the 61.8% extension. Pay attention that this is just below the 200 SMA – this is information for traders that the move may end there. After the correction, the Index moves down and ends exactly at the 161.8% extension. So as it can be seen in the table – there is a move from 61.8% to 161.8%.
Move to 161.8% extension
On this daily chart there was a correction down to the 50% retracement. Then, buyers came back, the 200 SMA (strong resistance before) was broken and euro started to move up strong. The move lasted up to the 161.8% extension.
Strong move up to the 161.8% extension line
Does it always work like this? Should you simply buy at 50% and sell at 161.8%? Is it that simple? No, it is not. It does not always work like this. In the example below, after a shallow correction to the 38.2% line, there is a strong move up to 161.8%.
Move to the 161.8% extension line
Has there been anything wrong with the table from the very beginning of the chapter? No, the table is just fine. You have to understand that it is about probability. As I mentioned before, there is a chance that the move from the 38.2% line would extend to at least 138.2%. It sometimes ends before that level, and sometimes the price moves further on.
How to use the table?
You have seen some examples of situations when the connections between the correction and extension move are very accurate. There are cases when they are not so useful. So, when to use the table? Whenever you are in doubt when to close your trade, it is wise to follow this rule. Remember, we are not here to catch bottoms and tops. We just want to make money. When you see that the price action is fast and you are confused about it, follow the table.
You can connect this with the money management system. Divide your position into 2 or 3 parts. Close the bigger part at the extension level based on the table, and let the rest of the position catch the rest of the move or scratch it when the move ends.
Let me assure you that, having a plan of when to exit, you place yourself in the top 20% of traders. The remaining 80% have no idea when to exit. They just go with the flow, hoping for the best. In the meantime, you make money.
Is it perfect? No, but it is a plan and you can include it into your trading plan.
Setting an exit place
When you are placing an exit order, it is a good idea to place it just before the level you plan to exit at. You should practice it yourself, but my advice is to place exit orders a few points earlier than the exit level.
There are two reasons for that.
Sometimes, the price will not touch the extension line, like in the previous examples. It may miss it just by a few points and it will still be a valid move to the Fibonacci extension line.
Another reason is that when the price reaches a certain extension line, you are not the only one trying to exit. The price might just touch the line and move back fast and your close order may not be completed.
By setting an exit point just in front of the extension line you increase your chances to close your trade with profit.
Surely, on certain occasions the price will move beyond the extension line. That is the life of a trader. The most important thing is to have a plan which can give you good exit points, and not tops and bottoms.
I have one observation regarding this way of closing positions.
The lower time frame you trade, the more you should follow rules from the table. On lower time frames, moves are very fast. People and “robots” trade here very actively and you should adjust to it. Do not try to catch the whole move from the beginning to the end. There are many opportunities here. Are you in a profitable trade? It is great. Now, if you are not sure where to exit, follow the table.
Way no. 2
Exiting a trade is very important, yet it is not so easy. We want to exit at the very best moment, but it is hard to tell when this moment comes. What is worse, the price very often climbs slowly to a certain level, and then suddenly it can fall hard.
Trying to exit at the top does not make sense, because there is always a chance that there will be another top and this one is only a stop. Be not concerned about catching tops.
In order to define a good exit point, we have to connect the Fibonacci extension levels, technical analysis and money management. With this, it is easier to decide when to close the position. I am not going to cheat you – on numerous occasions you will close your trade too early or too late. It is normal and you have to work on your exit strategy to make it better.
Any exit plan is better than simply letting the trade run and hoping for the best.
When it looks like that you have been correct and your trade is profitable, you move your stop loss to the entry point. This way, even when the price moves back, you will protect your capital.