Using Profit Targets Effectively
Learn to Trade Better

Profit Targets are often tough to pin-point for most traders. It would be great if we could always know when and where a trade will hit a certain price, but that is not the case. We, as professional traders, have to attempt to use our best judgment to determine where our best opportunity for profit targets lies. Even then, we have to be prepared for the unexpected.

Choosing a profit target levels can sometimes be frustrating. The purpose of choosing a profit target it to identify a price level where you would feel comfortable EXITING the trade. This level should be something that would be rather easy for the market to reach and not "too far away from current price". We want out trade to be successful - right? So we need to identify a profit target that we can live with and the maket will be able to attain.

Some common ways to establish a profit target are as follows...

1. 2 or 3 times the average candle range. This concept assumes the market will continue the expected trend for about 2 or 3 time the average candle range. So if the average candle range is $0.50, your profit target should be somewhere between $1.00 ~ $1.50.

2. Use Fibbonacci levels to establish a profit target. This method uses the "last trend" to determine a potential profit target for the future trend. I suggest using a Fibbonacci level LESS than 50% as your initial profit target. Anything greater than or equal to the 50% retracement levels is considered a pretty big move (in most cases).

3. Percentage Price Swings - often, professional traders use percentages of current price to establish stops/profit targets. The only suggestion I have when using this method is to compare the percentage level with #1 above. Often, normal price swings are smaller than a 1 or 2% price swing - or visa-versa. So, if you traded a $15.00 stock, 1% = $0.15 (rather small - right)?? Let's assume the average candle range was $0.27. By combining the first and second methods of determining a profit target shows the percentage type is too small and the candle range might be a bit too large. Thus, we might decide on something like a $0.35~0.45 profit target - about 3%.

4. Support/Resistance/Trend Channels - using these levels is another common form of identifying price targets. For example, if you can identify a support level or resistance level that the chart has recently bounced from, this level MAY be a decent target in the future. I like to use these when the market is moving "counter-trend". For example, let's assume the market is in a downtrend and it forming a new BUY SIGNAL. I would normally look for a price move up to a resistance level or downward trend channel level. Why - because this is likely where the upward price swing will end and I want to try to maximize my potential with this trade.

What to do when your profit target is reached

When your profit target is reached (first, pat yourself on the back for a great trade), then decide how you want to address the next phase of your trade. The reason you had a profit target in place was because you "needed to know exactly what to expect from your trade" - remember, we planned the whole thing out before you ever entered the trade. So, you planned on reaching this profit target, now you need to execute a portion of your strategy.

The process needed when your profit target is reached can contain any or all of the following..

Pulling some or all of your profits from the trade

1. Exiting 50%+ of your position - this process it taught by the Japanese as a "smart" technique. After your profit target has been reached - it is wise to pull 50~75% of your original trade off (to lock in the profits), then continue the trade with the rest. Of course, this means you still have to manage the remainder of your trade and adjust your protective stop.

2. Exit ALL of your trade and wait for the next one - no fault in taking this action. You made a calculated "guess" that the trade would reach this level - and it did. So, closing the trade out at this level means you were 100% successful. Now, you should be ready to do it again - right?

3. Leave your trade in place and adjust your protective mechanism - a bit more risky, but still some traders may choose this process. I like using #1 or #2 (personally). But adjusting a stop to lock in profits at this stage of the trade is very important. If you leave your trade in place and DON'T adjust your stop is somewhat foolish. You just earned that profit - don't you want ANY OF IT?

Adjusting existing protective levels

1. Adjusting your stop to break-even or better - this is the most common process for when your profit target is reached. The purpose of this it so adjust your protective stop to "lock in" a break-even (or better) price level. If the market turns against you right after your profit target is reached, you'll at least get out of the trade with little or no loss.

2. Adjusting your stops tighter, but still below breakeven - sometimes this happens because the price action of the chart prevents you from adjusting your stop to a level that is likely to be hit immediately. Remember, we are trying to use our stops as a protective method to prevent unwanted losses "IF" the market turns against us. But we also want to try to let the profits run. So, sometimes we have to adjust our stops to levels that are better, but not at or above break-even levels yet. If we give the market some extra time, we'll likely see additional opportunities to mofe our stops to above break-even.

Re-evaluating your trade for future potential activity

Now, the continuing saga or our trading experience.. Yes, we hav to continually evaluate our trades and the potential of our trades. We have to "manage" our trades - is a better way to put it. This process is simple, we need to reconfirm our actions, the potential for the markets and the location of our stops and profit targets.

There is no easy way to trade - sure everyone will tell you they found the "Key". But I've learned the best key is "Knowledge" and "planning your trade". If you know what to expect before you enter your trade, then you can make a decision based on the parameters presented before you - you know what your risk is, where your profit targets are and what the market conditions are. Thus, you know how much you could loose or gain before you start the trade.

As the market hits our profit target, we need to evaluate "where" we feel the market can go in the future. I like to trade Weekly stock charts and often find I'm holding positions for many weeks. Most of my clients are day-traders or short-term swing traders - so they may only hold positions for a few days (or weeks). The process is identical though, we have to manage our trades by attempting to contain our risks while allowing the trade to mature.

Weakness in the markets is something that happens - remember "Market Breath" and the fact that markets move in "waves" (up and down while continuing a trend). So, sometimes, you might see weakness in a chart that is actually just a short retracement or a slight pullback.

I suggest traders identify their goals, then adjust their protective measures to achieve their goals. If I were a short term swing trader, I would try to move my stops to above break-even immediately after reaching a profit target. If I saw any weakness in my trade, I might simply pull the entire trade and consider it a "good trade". If I could not stand any additional risks in my account, I would look for short term "quick" trades that return 3~7% (if possible) - but I would be happy with any winning trades.

My goal, as a longer term trader, is to contain my risks (to about 1~2%) and try to let my profits run. I do this by identifying support/resistance levels in my trades and letting the chart work itself out. Initially, I might have to risk a bit more (when I first enter the trade), but if I'm correct, I'll see an "impulse move" in my favor that allows me to adjust my stop to reduce my risk. I'll simply repeat this process over and over as the trend continues.