Limit Orders or No Limit Orders?

One of the conundrums that I periodically wrestle with is whether to use limit orders (also known as take-profit orders) to exit my trades at certain pre-determined levels. Should I take profits at 50 pips? 60 pips? 75 pips? Usually I start wondering about limit orders anytime the price moves dramatically in the right direction and then falls back close to where it started (or whipsaws), leaving me fuming that I missed out on major profits and wasted a day of trading.

Not coincidentally, this happened yesterday, which is why it's on my mind. I had a EUR/USD short trade in place and when I checked in on it first thing in the morning it showed 30 or so pips in profit. On paper, of course. Then over the next several hours the EUR/USD price drifted back up and I actually ended the day with a small loss. In hindsight a limit order (set at the right level of course - in hindsight they're always at the right level) would've grabbed those profits. So clearly I should be using them, right?

The fact is, though, I only use limit orders in very rare circumstances. If I'm going to be traveling and won't be able to closely monitor my trade, I'll sometimes set a limit order at a very conservative level to exit the trade with some profit without my involvement. But these are uncommon, one-off circumstances. In regular day-to-day trading, I don't use limit orders because in all of my backtesting, the data indicates I actually make more by leaving trades open-ended, allowing the price to rise or fall as much as it wants without setting an artificial limit on where I'll exit. Of course, in situations like yesterday's, I end up seriously doubting this conclusion, and suspect my tests were flawed and that limit orders are the answer. And yet the data continues to support a strategy of (1) not taking profits at pre-set levels and (2) only exiting trades when a shift from short to long or vice versa is indicated. An additional benefit is that this saves on spread costs, since I don't enter as many trades.

One strategy I haven't tried, because it would be a huge pain to put together, is contextual limit orders fine-tuned to a particular signal. So if signal A goes off, a take-profit at 75 pips is indicated, whereas if signal B is triggered, a limit order of 50 pips is deployed, and so on. Since I currently have a few dozen signals at work, this strategy would be incredibly time-consuming, with no guarantee I wouldn't end up with the same conclusion: no limit orders.

On the other hand, I have found there is some additional profit to be made by using stop-loss orders. However, even this is not that significant an amount, and the levels where I set my stop-losses are only reached very rarely. So on most days, I might as well not have a stop-loss in place. That said, I absolutely need them in place, for my peace of mind if nothing else.

But to return to limit/take profit orders: if you're spending a lot of time agonizing about the best place to set them, consider the possibility that you might not need them at all.

Related topics:
Simply Your Trading
Figuring out where to set your stop-losses