The Use of Dynamic Stops

Exits rules are part of the decision to take a trade. If the conditions for exiting positions are not fully defined when entering the trade, the trader may hold a losing position for too long in the hope of seeing the market returning. Inversely, the trader may not close a winning position at a high probability target, risking the trade to turn into a loss.

There are two types of exits:

- A stop loss to get out of a bad trade.
- A profit target to realize profits when the market moves in your favor.

Exit rules can take the form of fixed stops or limits-set in advance at a certain price levels, or dynamic exits using trailing stops, stop and reverse techniques, or conditions given by technical indicators.

Here at FXStreet, we make use of different kinds of dynamic stop loss rules in our Signals service. Here are some examples:

 

- A fixed pip amount. This is done with the Market Impact strategy. This strategy ignites trades based on the mathematical deviation between the Actual and Consensus figures. It finds out what was the average pip amount a certain pair reacted to a specific economic indicator, and sets the stop loss and the take profit in a 1:1 symmetrical ratio. Our traders may contextualize the trade in a bigger technical or macro view in order to assess a better risk/reward relationship, and alter therefore stops and targets during the life of the trade.

- A trailing stop. These can be fixed amount trailing stops which are usually not taking into account what the market is doing, and dynamic trailing stops. Our strategy Breakout Fibo 1H for instance, trails the stop to break-even in when a certain condition is given: the 1-hour close price, has to hurdle the first pivot point S or R on the way to the target (the 161.8% Fibonacci extension of the previous daily range).

- A stop adjusted to volatility. The advantage of adapting exits to volatility is that systems react to the same technical pattern or set-up in different volatility regimes. During the sell-off in March 2020, our Spread Reversion 30M strategy reacted extremely well to the increased volatility regime of those weeks. As you can see from the below performance chart, an initial loss of an exceptional pip amount was immediately recovered by a gain in a similar pip amount. A system using a fixed pip or trailing stop technique would have not endured the volatility explosion this well.

 

 

 

- A time stop. This is useful to get out of a trade and free your capital if the market is choppy. We use this technique in the Breakout Fibo strategy as well, allowing a maximum time duration of 2 days in case the trade is in negative territory.

- A technical level dictated by an indicator, a combination of indicators or a dynamic price level identified on a price chart. Although this is the most difficult way to place stops, it's also the smartest when you are working with automation. Since we base our Signals service on automated strategies, this is the most used type of exit in our strategies. 
Price-based indicators like moving averages and oscillators, change their positions during the life of a trade. This makes it impossible to know where and when the final exit price will be at the moment of the entry.

Take for instance the above mentioned Spread Reversion strategy. In order to exit a trade at a loss, it memorizes the Average True Range (set to 14 periods) at the moment of entry, multiplies it by a predetermined amount, and it exist the trade if the the distance between the actual price and the entry level is equal or higher than the ATR multiple. Each of the individual strategy-pair-timeframe combinations uses an optimized multiplier, which is usually 2 or 3.

This is how it looks like on a flow diagram:

 

The Relative Strength D strategy in turn, exits a trade when the initial entry condition is not given anymore. This strategy takes 28 currency pairs and measures their internal strength and momentum. Based on those two readings, the strategy then establishes a ranking of the strongest and weakest pairs and buys the top of the list and at the same time sells the pair(s) on the bottom. Should a pair fall from its top position or rise from the bottom, the strategy closes that trade either in profit or in loss.

 

Summarizing:

Exiting a trade is as important -if not more- than entering a trade. If all kinds of techniques are used to generate entry signals, why not use this same knowledge to build clever exits? Besides, dynamic stops have the advantage they are not known to the market and therefore not prone to be hit when market forces suck up liquidity at stop clusters.